UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-21842
-----------
First Trust Strategic High Income Fund II
----------------------------------------------------------------
(Exact name of registrant as specified in charter)
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
----------------------------------------------------------------
(Address of principal executive offices) (Zip code)
W. Scott Jardine, Esq.
First Trust Portfolios L.P.
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
----------------------------------------------------------------
(Name and address of agent for service)
registrant's telephone number, including area code: 630-765-8000
--------------
Date of fiscal year end: October 31
------------
Date of reporting period: April 30, 2013
----------------
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
FIRST TRUST
STRATEGIC
HIGH INCOME
FUND II
Semi-Annual
Report
For the Six Months Ended
April 30, 2013
FIRST TRUST BROOKFIELD
--------------------------------------------------------------------------------
TABLE OF CONTENTS
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II (FHY)
SEMI-ANNUAL REPORT
APRIL 30, 2013
Shareholder Letter .......................................................... 1
At A Glance ................................................................. 2
Portfolio Commentary ........................................................ 3
Portfolio of Investments .................................................... 7
Statement of Assets and Liabilities ......................................... 15
Statement of Operations ..................................................... 16
Statements of Changes in Net Assets ......................................... 17
Statement of Cash Flows ..................................................... 18
Financial Highlights ........................................................ 19
Notes to Financial Statements ............................................... 20
Additional Information ...................................................... 28
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934,
as amended. Forward-looking statements include statements regarding the goals,
beliefs, plans or current expectations of First Trust Advisors L.P. ("First
Trust" or the "Advisor") and/or Brookfield Investment Management Inc.
("Brookfield" or the "Sub-Advisor") and their respective representatives, taking
into account the information currently available to them. Forward-looking
statements include all statements that do not relate solely to current or
historical fact. For example, forward-looking statements include the use of
words such as "anticipate," "estimate," "intend," "expect," "believe," "plan,"
"may," "should," "would" or other words that convey uncertainty of future events
or outcomes.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
First Trust Strategic High Income Fund II (the "Fund") to be materially
different from any future results, performance or achievements expressed or
implied by the forward-looking statements. When evaluating the information
included in this report, you are cautioned not to place undue reliance on these
forward-looking statements, which reflect the judgment of the Advisor and/or
Sub-Advisor and their respective representatives only as of the date hereof. We
undertake no obligation to publicly revise or update these forward-looking
statements to reflect events and circumstances that arise after the date hereof.
PERFORMANCE AND RISK DISCLOSURE
There is no assurance that the Fund will achieve its investment objectives. The
Fund is subject to market risk, which is the possibility that the market values
of securities owned by the Fund will decline and that the value of the Fund
shares may therefore be less than what you paid for them. Accordingly, you can
lose money by investing in the Fund. See "Risk Considerations" in the Notes to
Financial Statements for a discussion of certain other risks of investing in the
Fund.
Performance data quoted represents past performance, which is no guarantee of
future results, and current performance may be lower or higher than the figures
shown. For the most recent month-end performance figures, please visit
http://www.ftportfolios.com or speak with your financial advisor. Investment
returns, net asset value and common share price will fluctuate and Fund shares,
when sold, may be worth more or less than their original cost.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment. It
includes details about the Fund and presents data and analysis that provide
insight into the Fund's performance and investment approach.
By reading the portfolio commentary by the portfolio management team of the
Fund, you may obtain an understanding of how the market environment affected the
Fund's performance. The statistical information that follows may help you
understand the Fund's performance compared to that of relevant market
benchmarks.
It is important to keep in mind that the opinions expressed by personnel of
Brookfield are just that: informed opinions. They should not be considered to be
promises or advice. The opinions, like the statistics, cover the period through
the date on the cover of this report. The risks of investing in the Fund are
spelled out in the prospectus, the statement of additional information, this
report and other Fund regulatory filings.
--------------------------------------------------------------------------------
SHAREHOLDER LETTER
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II SEMI-ANNUAL
LETTER FROM THE CHAIRMAN AND CEO
APRIL 30, 2013
Dear Shareholders:
I am pleased to present you with the semi-annual report for your investment in
First Trust Strategic High Income Fund II (the "Fund").
The report you hold contains detailed information about your investment; a
portfolio commentary from the Fund's management team that provides a recap of
the period; a performance analysis and a market and Fund outlook. Additionally,
you will find the Fund's financial statements for the period this report covers.
I encourage you to read this document and discuss it with your financial
advisor. A successful investor is also typically a knowledgeable one, as we have
found to be the case at First Trust Advisors L.P. ("First Trust").
The six months covered by this report have been more positive for the U.S.
markets. In fact, the S&P 500 Index, as measured on a total return basis, rose
14% during the period, and many economists and investors have felt positive
about the current market environment. Of course, past performance can never be
an indicator of future performance. As I have written many times, First Trust
believes that staying invested in quality products through up and down markets
and having a long-term horizon can help investors reach their financial goals.
As you know, First Trust offers a variety of products that we believe could fit
many financial plans to help investors seeking long-term investment success. We
encourage you to talk to your advisor about the other investments First Trust
offers that might also fit your financial goals and to discuss those goals with
your advisor regularly so that he or she can help keep you on track.
First Trust will continue to make available up-to-date information about your
investments so you and your financial advisor are current on any First Trust
investments you own. We value our relationship with you, and thank you for the
opportunity to assist you in achieving your financial goals. I look forward to
the remainder of 2013 and to the next edition of your Fund's report.
Sincerely,
/s/ James A. Bowen
James A. Bowen
Chairman of the Board of Trustees of First Trust Strategic High Income Fund II
and Chief Executive Officer of First Trust Advisors L.P.
Page 1
FIRST TRUST STRATEGIC HIGH INCOME FUND II
"AT A GLANCE"
AS OF APRIL 30, 2013 (UNAUDITED)
-------------------------------------------------------------------
FUND STATISTICS
-------------------------------------------------------------------
Symbol on New York Stock Exchange FHY
Common Share Price $17.41
Common Share Net Asset Value ("NAV") $17.91
Premium (Discount) to NAV (2.79)%
Net Assets Applicable to Common Shares $151,458,525
Current Monthly Distribution per Common Share (1) $0.120
Current Annualized Distribution per Common Share $1.440
Current Distribution Rate on Closing Common Share Price (2) 8.27%
Current Distribution Rate on NAV (2) 8.04%
------------------------------------------------
COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE)
------------------------------------------------
Common Share Price NAV
4/12 17.34 16.69
17.11 16.68
17.28 16.67
15.82 16.38
5/12 16.76 16.29
16.36 16.04
16.73 16.13
16.38 16.09
16.83 16.30
6/12 17.03 16.41
17.00 16.39
17.13 16.49
17.36 16.61
7/12 17.58 16.58
17.59 16.64
17.51 16.73
17.46 16.72
17.28 16.80
8/12 17.45 16.83
17.30 16.88
17.79 17.16
17.68 17.18
9/12 17.84 17.04
17.88 17.04
17.65 17.03
17.69 17.13
10/12 17.77 17.08
17.78 16.98
17.43 16.93
16.40 16.79
16.68 16.91
11/12 17.05 17.06
16.59 17.12
16.42 17.24
16.57 17.27
12/12 16.43 17.28
16.93 17.34
17.02 17.52
17.20 17.56
1/13 17.28 17.66
17.09 17.47
17.03 17.42
17.15 17.46
2/13 17.20 17.46
17.45 17.38
17.36 17.48
16.89 17.55
17.19 17.56
3/13 17.26 17.60
17.14 17.50
17.32 17.64
17.20 17.64
17.35 17.81
4/13 17.41 17.91
------------------------------------------------------------------------------------------------------------------
PERFORMANCE
------------------------------------------------------------------------------------------------------------------
Average Annual Total Return
-------------------------------------
6 Months Ended 1 Year Ended 5 Years Ended Inception (3/28/2006)
4/30/2013 4/30/2013 4/30/2013 to 4/30/2013
FUND PERFORMANCE (3)
NAV 9.62% 17.48% -0.64% -3.24%
Market Value 2.76% 9.92% -3.32% -4.25%
INDEX PERFORMANCE
Barclays Capital Ba U.S. High Yield Index 5.62% 12.71% 11.60% 9.65%
------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------
% OF TOTAL
ASSET CLASSIFICATION INVESTMENTS
--------------------------------------------------------
Corporate Bonds and Notes 80.3%
Foreign Corporate Bonds and Notes 6.6
Manufactured Housing Loans 5.5
Residential Mortgage-Backed Securities 4.3
Senior Floating-Rate Loan Interests 1.6
Commercial Mortgage-Backed Securities 1.3
Collateralized Mortgage Obligations 0.4
Equity 0.0*
Collateralized Debt Obligations 0.0*
--------------------------------------------------------
Total 100.0%
======
* Amount is less than 0.1%.
--------------------------------------------------------
% OF TOTAL
FIXED-INCOME
CREDIT QUALITY (4) INVESTMENTS
--------------------------------------------------------
AAA 0.6%
AA- 0.5
A 1.1
A- 1.0
BBB+ 0.1
BBB- 1.8
BB+ 6.5
BB 6.4
BB- 13.6
B+ 17.6
B 15.3
B- 16.9
CCC+ 11.0
CCC 2.0
CCC- 1.6
CC 1.2
C 1.2
D 1.2
NR 0.4
--------------------------------------------------------
Total 100.0%
======
(1) Most recent distribution paid or declared through 4/30/2013. Subject to
change in the future.
(2) Distribution rates are calculated by annualizing the most recent
distribution paid or declared through
the report date and then dividing by Common Share price or NAV, as applicable,
as of 4/30/2013. Subject to change in the future. (3) Total return is
based on the combination of reinvested dividend, capital gain and return
of capital distributions, if any, at prices obtained by the Dividend
Reinvestment Plan and changes in NAV per share for NAV returns and changes
in Common Share price for market value returns. Total returns do not
reflect sales load and are not annualized for periods less than one year.
Past performance is not indicative of future results.
(4) The credit quality and ratings information presented above reflects the
ratings assigned by one or more nationally recognized statistical rating
organizations (NRSROs), including Standard & Poor's Ratings Group, a
division of the McGraw Hill Companies, Inc., Moody's Investors Service,
Inc., Fitch Ratings or a comparably rated NRSRO. For situations in which a
security is rated by more than one NRSRO and the ratings are not
equivalent, the highest ratings are used. Sub-investment grade ratings are
those rated BB+/Ba1 or lower. Investment grade ratings are those rated
BBB-/Baa3 or higher. The credit ratings shown relate to the credit
worthiness of the issuers of the underlying securities in the Fund, and
not to the Fund or its shares. Credit ratings are subject to change.
NR Not rated
Page 2
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II (FHY)
SEMI-ANNUAL REPORT
APRIL 30, 2013
SUB-ADVISOR
BROOKFIELD INVESTMENT MANAGEMENT INC.
Brookfield Investment Management Inc. ("Brookfield") serves as the Fund's
Sub-Advisor. Brookfield is a wholly-owned subsidiary of Brookfield Asset
Management, a global alternative asset manager with over $184 billion in assets
under management as of March 31, 2013. Brookfield Asset Management has over a
100-year history of owning and operating assets with a focus on property,
renewable power, infrastructure and private equity. The company offers a range
of public and private investment products and services, which leverage its
expertise and experience and provide it with a competitive advantage in the
markets where it operates. On behalf of its clients, Brookfield Asset Management
is also an active investor in the public securities markets, where its
experience extends over 30 years. Over this time, the company has successfully
developed several investment operations and built expertise in the management of
institutional portfolios, retail mutual funds, and structured product
investments.
Brookfield Asset Management's public market activities are conducted by
Brookfield Investment Management, a registered investment advisor. These
activities complement Brookfield Asset Management's core competencies and
include global listed real estate and infrastructure equities, corporate
high-yield investments, opportunistic credit strategies and a dedicated
insurance asset management division. Headquartered in New York, NY, Brookfield
Investment Management maintains offices and investment teams in Toronto,
Chicago, Boston and London and has over $10 billion of assets under management
as of March 31, 2013.
PORTFOLIO MANAGEMENT TEAM
DANA E. ERIKSON, CFA
MANAGING DIRECTOR
Mr. Erikson, Senior Portfolio Manager and the Head of the Global High Yield
Team, is responsible for the firm's corporate high-yield exposures and the
establishment of portfolio objectives and strategies. Mr. Erikson has 27 years
of investment experience. Prior to joining the firm, he was with Evergreen
Investments or one of its predecessor firms since 1996. He was a senior
portfolio manager and the Head of the High Yield team. Prior to that, he was
Head of High Yield Research. Mr. Erikson received a Bachelor of Arts in
Economics from Brown University and an MBA, with honors, from Northeastern
University. He is a member of the Boston Security Analysts Society. He holds the
Chartered Financial Analyst designation.
ANTHONY BREAKS, CFA
SENIOR DIRECTOR
Mr. Breaks, who has over 15 years of investment experience, is a Portfolio
Manager on the Securitized Products Investments Team. He is a team leader in
mortgage-backed securities ("MBS") and asset-backed securities. Mr. Breaks has
also managed securitized products vehicles, such as structured investment
vehicles ("SIV"), asset-backed commercial paper ("ABCP") and collateralized debt
obligations ("CDOs") for Brookfield and has experience in insurance company
asset management. Mr. Breaks earned a Bachelor of Science degree in electrical
engineering from the Massachusetts Institute of Technology. He holds the
Chartered Financial Analyst designation.
COMMENTARY
FIRST TRUST STRATEGIC HIGH INCOME FUND II
The primary investment objective of the First Trust Strategic High Income Fund
II ("FHY" or the "Fund") is to seek a high level of current income. The Fund
seeks capital growth as a secondary objective. The Fund seeks to achieve its
investment objectives by investing in a diversified portfolio of
below-investment grade and investment grade debt securities and equity
securities that the Sub-Advisor believes offer attractive yield and/or capital
appreciation potential. There can be no assurance that the Fund will achieve its
investment objectives. The Fund may not be appropriate for all investors.
MARKET RECAP AND OUTLOOK
High Yield
Early in the six-month period, all eyes were focused on the Presidential
elections, which appeared to be too close to call right up to the last minute,
but which seemed to offer two drastically different visions for the country.
Immediately following the re-election of President Obama, focus shifted to the
so-called "fiscal cliff:" automatic tax increases of such magnitude that many
economists warned of recession. A last minute compromise softened the blow,
shortly followed by federal spending cuts on March 1 under the sequester. While
these were responsible steps toward fiscal responsibility at the federal level,
they
Page 3
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY - (CONTINUED)
--------------------------------------------------------------------------------
were surrounded by intense political rhetoric which may have shattered consumer
confidence. Fortunately, both consumers and markets looked through the politics
and remained positive. Also in March, worry was fueled by a banking crisis in
Cyprus which raised the possibility of insured bank depositors receiving less
than the full value on their deposits. While the final resolution made insured
depositors whole, Cyprus imposed capital controls, which runs counter to
resolutions by the European Union ("EU") and may bode poorly for other
peripheral European countries. Investors once again questioned the integrity of
the EU. As if that weren't enough, commentators began carefully watching
economic releases for possible signs of a fourth consecutive summer slowdown
with attendant market correction.
It is sometimes said that financial markets climb a "wall of worry" to higher
returns. These repeated crises may have been just such a wall and investors
ultimately returned to a "risk-on" posture, driving equity markets to record or
near-record highs. As the high-yield bond market tends to be more correlated to
equities than Treasuries, it is not surprising that the high-yield market
returned a strong 7.3% over the reporting period despite stable interest rates.
U.S. Treasury yields, as measured by the 10-year Treasury bond, fell two basis
points this period. Flat Treasury yields, coupled with strong high-yield market
returns, pushed the high-yield market spread down to 444 basis points from 547
basis points at the beginning of the quarter. While this represents a
significantly lower spread than we have seen in a while, spreads remain wide to
the level normally seen at this point in the credit cycle and may indicate that
the market retains value.
Typically in a bull market, the more volatile lower quality credits outperform
better quality names, and we saw that this quarter. CCC rated bonds
outperformed, returning 11.3% in the period, compared to 7.3% for single B rated
bonds.
Corporate credit has been sound for the past few years, and the current default
rate is 1.2%.(1) This remains well below the market's 25-year average default
rate of 4.2%.(2) The 2013 calendar year begins the fourth year in which
high-yield defaults are less than 2%, which is normal for the middle part of the
credit cycle. It is not unusual, however, for the default rate to pop up in any
individual year for idiosyncratic, as opposed to systemic, reasons.
The period saw stability in ratings agency activity which began deteriorating in
the third quarter of 2011. The trailing twelve-month upgrade/downgrade ratio
ended at 1.0x.(3) This means that credit is stable, as measured by the ratings
agencies. Brookfield noted that companies reported generally acceptable cash
flow, but we are continuing to see challenging earnings and continued cutting of
forward estimates.
In the period, the market saw outperformance in technology, basic industry, and
banking, which were up 9.6%, 8.4% and 8.4%, respectively.(4) Outperformers
tended to be sectors with greater credit risk or greater sensitivity to economic
growth. Underperforming sectors included media, telecommunications, and real
estate, which were up 5.8%, 6.0%, and 6.0% respectively.(4) The media sector
lagged due to the low-risk nature of cable television companies and poor
economics in publishing. Bonds in the telecommunications sector were depressed
by the shareholder-friendly actions of some companies and real estate companies
tended to be price-constrained due to positive performance in the past.
Fund flows turned positive and new issue volume has been essentially flat so far
in 2013. Debt refinancing continued to be the primary use of proceeds for new
issuers, representing 68% of all volume, up from 60% last year. Refinancings
have the effect of reducing overall risk to high-yield investors by extending
debt maturities and reducing "credit hammers." Over the past four years,
companies have refinanced a great deal of debt, leaving them with very
manageable debt service requirements.
For most of the past year, our view has been that the high-yield bond market has
struck a balance between spreads, which are more attractive than usual for the
current phase of the credit cycle, and prices, which are well above par and
approaching record highs. Last quarter we noted the historical seasonality of
high-yield returns; November through May typically represents seasonally strong
periods, while June through October typically represents seasonally challenging
periods. This period followed the typical pattern as investors went "risk-on"
and the high-yield market moved higher.
We retain our positive view of credit and note that new issue trends have lately
been risk-reducing rather than risk-additive. Refinancings are up, new issue
credit quality is up, mergers and acquisition activity is muted, and despite the
headlines surrounding the possible leveraged buyouts of Heinz and Dell, LBO
activity is moderate. As we survey the leveraged-finance landscape, we see more
signs of re-risking in the leveraged loan market than the high-yield bond
market, which may work to the benefit of high-yield bond investors.
We remain very concerned about global political and economic risks as countries
in Europe and North America struggle with structural deficits, ballooning debt,
and pension liabilities. While markets shrugged off the combined effects of the
"fiscal cliff," sequestration, and Cyprus this period, they may not prove so
forgiving in the future. As economic growth in the U.S. takes root and deepens,
and as a newly rebounding housing market fuels growth, investors are
increasingly asking when the
-------------------
1 JP Morgan, High Yield Default Monitor, April 1, 2013, p.1.
2 JP Morgan, High Yield Default Monitor, April 1, 2013, p.2.
3 JP Morgan, High Yield Default Monitor, April 1, 2013, p.10.
4 FactSet analysis for the six-month period ended April 30, 2013.
Page 4
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY - (CONTINUED)
--------------------------------------------------------------------------------
Federal Reserve will phase out its stimulative policies and allow interest rates
to move higher. While the high-yield bond market has historically had little
correlation to Treasury bonds, there is always the possibility that rising rates
could offset an otherwise positive environment.
The high-yield market is trading at a substantial premium to par value, which we
believe substantially limits further upside appreciation. Investors, therefore,
should look at current yield as the best indicator of possible future total
returns and evaluate the attractiveness of the market on that basis, rather than
past total return. We note that the absolute level of yield in the high-yield
market is at or near historic lows, but point out that yield spread to
government bond rates remains attractive given the current state of corporate
credit.
Securitized Products
Within the Securitized Products' universe, non-agency residential
mortgage-backed securities ("RMBS") and commercial mortgage-backed securities
("CMBS") both had strong returns for the-six month period driven by improving
fundamentals and extraordinary demand. Issuance of new issue prime deals from
dealer conduits and REITs have become frequent, although volumes remain far
below pre-crisis levels. CMBS issuance continued its recovery with $37.9 billion
in new unguaranteed deals and $31.5 billion in agency-guaranteed CMBS. Agency
derivatives, which include interest only ("IO") and inverse IO securities,
declined in prices during the fourth quarter of 2012 but rose in the first
quarter of 2013. Rising interest rates and slower prepayment speeds during the
first quarter led to higher valuation for agency derivatives. We believe agency
derivatives will benefit the portfolio when interest rates shift upward in the
long term. We continue to see value in the Fund's derivative holdings which
generally have elements of protection from prepayment speeds over the long term.
For the U.S. housing market, we believe the low point in prices has passed and
the last 12 to 18 months of data have shown consistent strength. The six-month
period would have typically shown tepid to negative price levels because the
winter months see less home buying demand. In fact, we saw prices increase
nationally. Investors in securitized products were typically running
conservative assumptions and so the rebound in housing represents a change
versus prior forward expectations. The evolution in assumptions has come to
incorporate a base line of home price appreciation. We are seeing the improved
assumptions in higher prices for bonds, especially those backed by loans most
sensitive to housing prices, such as subprime securities, where we have placed
particular emphasis.
Technical factors are still in favor of agency pass-through securities and
Collateralized Mortgage Obligations ("CMOs"). The Federal Reserve is purchasing
$40 billion of agency MBS per month and it is likely that the program will last
at least until the end of the year. The Federal Reserve's mortgage purchases
will remain the dominant factor in the supply and demand balance, which we
believe will support mortgage prices. The mortgage basis is modestly attractive
at the current level. We are focused on lower coupon TBAs ("to be announced"
trade) for agency mortgage exposure as the monthly carries on these TBAs are
attractive.
We remain positive on most securitized products for the remainder of 2013, based
on continued improvement in forecasts for collateral performance and lower
required yields from investors. With a contraction in the premium for risk, we
remain focused on stability and income in evaluating mortgage investments. For
many investors, mortgage-backed securities are part of a few remaining products
that can offer that stability while still meeting return hurdles. Market
sentiment has become positive on housing and housing-related sectors on the view
that downside is limited and improvement will be the norm, as it has been for
about 15 months. We have been encouraged by positive housing data and our
leading indicators these last few quarters and have responded by purchasing
securities backed by higher "beta" collateral such as Subprime and Option ARM
loans. In the preceding semi-annual period, we saw those investments outperform
lower beta products such as fixed coupon prime mortgage-backed securities
("MBS"). We continue to believe this is the best positioning for the portfolio
as housing continues its recovery.
Agency MBS returned -0.27% over the six-month period, although this sector
benefited from support through the Federal Reserve's mortgage purchase program.
The program started in September 2012 at a pace of $40 billion of agency MBS
pools per month. Since the program was well anticipated by the market, most
price appreciation of agency MBS appears to have occurred before September
instead of after the actual announcement. This would explain why the performance
of agency MBS did not improve during the six-month period. Given that the net
issuance of agency MBS was close to zero, the extra demand from the Federal
Reserve helped maintain the prices of agency MBS at premium levels. This
activity helped the Fund's specified pools and CMO holdings.
In the non-agency MBS side, virtually all sectors within the Fund's investment
guidelines rallied during the period, generally lowering projected yields.
Collateral assumptions are trending toward the upside due to improving housing
data as well as assumptions regarding defaults and loss severities. For many
securities, especially those projected to take principal losses, this has
supported forecasted yields even as prices have risen. The assumption of better
collateral performance leads to smaller bond loss projections and therefore
better yields at a given price. For securities expected to pay in full, improved
collateral performance cannot generally improve the yield at a given price.
There are no losses to cure with the improved performance. For the Fund's "A" or
better allocations, losses are projected to be zero (or quite small), so the
price increases
Page 5
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY - (CONTINUED)
--------------------------------------------------------------------------------
pose a particular challenge. To the degree that we can, we look to sell bonds
that have little performance upside to improving housing fundamental in favor of
those we believe can and will continue to rally. The price appreciation
potential can make up for what can be modest yields to maturity and we also look
for split investment-grade rated and less liquid securities that offer higher
yields.
Performance Analysis
For the six months ended April 30, 2013, the Fund had a total return(5) of 9.62%
based on net asset value ("NAV"). For the period, the Fund traded from a premium
to NAV of 3.69% to a discount of -2.79%, resulting in a total return(5) of
2.76%, based on market price.
The total return for the Fund's benchmark, the Barclays Capital Ba U.S. High
Yield Index, was 5.62% for the six months ended April 30, 2013. While the
benchmark contains mostly corporate debt, it is important to note that the Fund
maintained exposure to structured finance and mortgage-related securities during
the period.
As of April 30, 2013, the Fund's leverage was approximately 26.42% of Managed
Assets, which contributed positively to the Fund's performance during the
period. However, the Fund may utilize leverage in an amount up to 33.33% of
Managed Assets. Where our overall budget for risk warrants it and when the
return opportunities are compelling, we are likely to increase leverage in an
attempt to improve returns. In periods of stability, this may be an especially
important tool.
An important factor impacting the return of the Fund relative to its benchmarks
was the Fund's use of financial leverage through the use of bank borrowings. The
Fund uses leverage because its managers believe that, over time, leverage
provides opportunities for additional income and total return for common
shareholders. However, the use of leverage also can expose common shareholders
to additional volatility. For example, as the prices of securities held by the
Fund decline, the negative impact of the valuation changes on common share net
asset value and common shareholder total return is magnified by the use of
leverage. Conversely, leverage may enhance common share returns during periods
when the prices of securities held by the Fund generally are rising.
Contributors to performance included the Fund's overweight in the basic industry
sector, which outperformed the market, coupled with strong security selection of
the bonds in that sector, particularly in building materials, chemicals and
forest products. The Fund also benefited from strong security selection in the
automotive sector, particularly among auto parts suppliers which outperformed
the market.
Detractors from performance came from below-average security selection in the
consumer cyclical sector, particularly among food and drug retailers, where
conservative bonds underperformed in the current strong market. Also detracting
from performance were bonds in the consumer non-cyclical sector, particularly
the food sector, where call-constrained bonds held by the Fund lagged the
overall market.
The Fund's portfolio holdings are subject to change without notice. The mention
of specific securities is not a recommendation or solicitation for any person to
buy, sell or hold any particular security. There is no assurance that the Fund
currently holds these securities.
These views represent the opinions of Brookfield Investment Management Inc. and
are not intended to predict or depict the performance of any investment. These
views are as of the close of business on April 30, 2013 and subject to change
based on subsequent developments.
-------------------
5 Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by
the Dividend Reinvestment Plan and changes in NAV per share for NAV
returns and changes in Common Share price for market value returns and
does not reflect sales load. Past performance is not indicative of future
results.
Page 6
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS
APRIL 30, 2013 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------ ---------------------------------------------------- ----------- ---------- -------------
CORPORATE BONDS AND NOTES - 106.6%
AUTOMOTIVE - 6.6%
$ 1,700,000 American Axle & Manufacturing, Inc.................. 6.25% 03/15/21 $ 1,799,875
600,000 American Axle & Manufacturing, Inc.................. 6.63% 10/15/22 644,250
1,750,000 Chrysler Group LLC/Chrysler Group Co-Issuer,
Inc. (a) ......................................... 8.25% 06/15/21 2,016,875
1,500,000 Ford Motor Co. (a) ................................. 6.50% 08/01/18 1,786,189
2,000,000 Pittsburgh Glass Works LLC (a) (b) ................. 8.50% 04/15/16 2,070,000
425,000 Tenneco, Inc........................................ 6.88% 12/15/20 471,219
1,150,000 Visteon Corp. (a) .................................. 6.75% 04/15/19 1,246,313
-------------
10,034,721
-------------
BASIC INDUSTRY - 17.6%
1,500,000 AK Steel Corp. (a) ................................. 7.63% 05/15/20 1,308,750
1,025,000 Alpha Natural Resources, Inc........................ 6.25% 06/01/21 948,125
1,525,000 ArcelorMittal ...................................... 6.13% 06/01/18 1,672,309
1,675,000 Arch Coal, Inc. (a) ................................ 8.75% 08/01/16 1,750,375
975,000 Arch Coal, Inc...................................... 7.25% 06/15/21 897,000
1,750,000 Associated Materials LLC (a) ....................... 9.13% 11/01/17 1,896,562
500,000 Building Materials Corp. of America (b) ............ 6.75% 05/01/21 555,000
1,160,000 Georgia-Pacific LLC (a) ............................ 7.38% 12/01/25 1,614,139
415,000 Georgia-Pacific LLC (a) ............................ 7.25% 06/01/28 556,427
1,750,000 Hexion US Finance Corp.............................. 9.00% 11/15/20 1,828,750
1,100,000 Huntsman International LLC (a) ..................... 8.63% 03/15/21 1,270,500
1,750,000 Ply Gem Industries, Inc. (a) ....................... 8.25% 02/15/18 1,925,000
1,700,000 Polymer Group, Inc. (a) ............................ 7.75% 02/01/19 1,876,375
1,000,000 Steel Dynamics, Inc. (a) ........................... 7.63% 03/15/20 1,125,000
825,000 United States Steel Corp............................ 7.00% 02/01/18 888,938
675,000 United States Steel Corp. (a) ...................... 7.38% 04/01/20 715,500
2,100,000 USG Corp. (a) (c) .................................. 9.75% 01/15/18 2,504,250
1,750,000 Verso Paper Holdings LLC/Verso Paper, Inc........... 11.75% 01/15/19 1,885,625
1,425,000 Xerium Technologies, Inc. (a) ...................... 8.88% 06/15/18 1,464,187
-------------
26,682,812
-------------
CAPITAL GOODS - 9.5%
1,750,000 Berry Plastics Corp. (a) ........................... 9.50% 05/15/18 1,955,625
1,750,000 Coleman Cable, Inc. (a) ............................ 9.00% 02/15/18 1,903,125
1,700,000 Crown Cork & Seal Co., Inc. (a) .................... 7.38% 12/15/26 1,946,500
1,755,000 Mueller Water Products, Inc. (a) ................... 7.38% 06/01/17 1,812,037
1,750,000 Owens-Illinois, Inc. (a) ........................... 7.80% 05/15/18 2,078,125
950,000 Tekni-Plex, Inc. (b) ............................... 9.75% 06/01/19 1,059,250
650,000 Terex Corp.......................................... 6.50% 04/01/20 711,750
1,350,000 Terex Corp.......................................... 6.00% 05/15/21 1,458,000
1,425,000 Trinseo Materials Operating S.C.A. (b) ............. 8.75% 02/01/19 1,428,563
-------------
14,352,975
-------------
CONSUMER CYCLICAL - 5.6%
1,750,000 Levi Strauss & Co. (a) ............................. 7.63% 05/15/20 1,953,437
1,775,000 Limited Brands, Inc. (a) ........................... 7.60% 07/15/37 1,959,156
1,500,000 Michaels Stores, Inc................................ 7.75% 11/01/18 1,655,625
See Notes to Financial Statements Page 7
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS - (CONTINUED)
APRIL 30, 2013 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------ ---------------------------------------------------- ----------- ---------- -------------
CORPORATE BONDS AND NOTES - (CONTINUED)
CONSUMER CYCLICAL - (CONTINUED)
$ 550,000 Phillips-Van Heusen Corp. (a) ...................... 7.38% 05/15/20 $ 620,813
2,100,000 Reynolds Group Issuer, Inc. (a) .................... 9.00% 04/15/19 2,278,500
-------------
8,467,531
-------------
CONSUMER NON-CYCLICAL - 3.6%
1,226,000 B&G Foods, Inc...................................... 7.63% 01/15/18 1,321,015
1,350,000 C&S Group Enterprises LLC (b) ...................... 8.38% 05/01/17 1,458,000
425,000 Cott Beverages, Inc. (a) ........................... 8.13% 09/01/18 468,562
1,000,000 Easton-Bell Sports, Inc. (a) ....................... 9.75% 12/01/16 1,077,510
1,125,000 YCC Holdings LLC ................................... 10.25% 02/15/16 1,167,199
-------------
5,492,286
-------------
ENERGY - 15.6%
1,750,000 Breitburn Energy Partners LP/Breitburn .............
Finance Corp. (a) ................................ 8.63% 10/15/20 1,964,375
250,000 Breitburn Energy Partners LP/Breitburn
Finance Corp...................................... 7.88% 04/15/22 276,250
425,000 Calfrac Holdings LP (a) (b) ........................ 7.50% 12/01/20 439,875
1,875,000 Crosstex Energy LP/Crosstex Energy Finance
Corp. (a) ........................................ 8.88% 02/15/18 2,057,812
2,060,000 EV Energy Partners LP/EV Energy Finance
Corp. (a) ........................................ 8.00% 04/15/19 2,204,200
816,163 GMX Resources, Inc. (a) (d) (j) .................... 11.00% 12/01/17 759,032
1,050,000 Hercules Offshore LLC (a) (b) ...................... 10.50% 10/15/17 1,147,125
1,700,000 Hilcorp Energy I LP/Hilcorp Finance
Co. (a) (b) ...................................... 8.00% 02/15/20 1,895,500
1,750,000 Key Energy Services, Inc. (a) ...................... 6.75% 03/01/21 1,837,500
950,000 Linn Energy LLC/Linn Energy Finance
Corp. (a) ........................................ 8.63% 04/15/20 1,066,375
800,000 Linn Energy LLC/Linn Energy Finance Corp............ 7.75% 02/01/21 880,000
1,840,000 Niska Gas Storage US LLC/Niska Gas Storage
Canada ULC (a) ................................... 8.88% 03/15/18 1,982,600
1,275,000 Pioneer Natural Resources Co. (a) .................. 6.65% 03/15/17 1,496,953
1,675,000 Plains Exploration & Production Co. (a) ............ 7.63% 06/01/18 1,753,516
650,000 Quicksilver Resources, Inc. (a) .................... 11.75% 01/01/16 697,937
294,000 Sesi LLC (a) ....................................... 6.88% 06/01/14 294,735
250,000 Vanguard Natural Resources LLC/VNR
Finance Corp...................................... 7.88% 04/01/20 272,500
2,100,000 Venoco, Inc. (a) ................................... 8.88% 02/15/19 2,126,250
415,000 W&T Offshore, Inc................................... 8.50% 06/15/19 454,425
-------------
23,606,960
-------------
FINANCIAL SERVICES - 1.6%
525,000 General Motors Financial Co., Inc. (b) ............. 4.75% 08/15/17 556,500
1,750,000 Level 3 Communications, Inc. (a) (b) ............... 8.88% 06/01/19 1,940,313
-------------
2,496,813
-------------
HEALTHCARE - 7.3%
1,750,000 Community Health Systems, Inc. (a) ................. 7.13% 07/15/20 1,957,813
Page 8 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS - (CONTINUED)
APRIL 30, 2013 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------ ---------------------------------------------------- ----------- ---------- -------------
CORPORATE BONDS AND NOTES - (CONTINUED)
HEALTHCARE - (CONTINUED)
$ 1,000,000 DJO Finance LLC/DJO Finance Corp.................... 9.88% 04/15/18 $ 1,107,500
1,750,000 HCA, Inc. (a) ...................................... 8.00% 10/01/18 2,084,687
900,000 Health Management Associates, Inc................... 7.38% 01/15/20 1,003,500
1,045,000 inVentiv Health, Inc. (b) .......................... 10.75% 08/15/18 914,375
1,725,000 Jaguar Holdings Co./Merger (a) (b) ................. 9.50% 12/01/19 2,005,312
1,925,000 Kindred Healthcare, Inc............................. 8.25% 06/01/19 1,989,969
-------------
11,063,156
-------------
MEDIA - 8.8%
1,700,000 American Reprographics Co. (a) ..................... 10.50% 12/15/16 1,738,250
1,850,000 Cablevision Systems Corp. (a) ...................... 8.63% 09/15/17 2,206,125
1,700,000 CCO Holdings LLC/CCO Holdings Capital
Corp. (a) ........................................ 8.13% 04/30/20 1,929,500
1,700,000 Clear Channel Communications, Inc. (a) ............. 9.00% 03/01/21 1,670,250
1,850,000 Cumulus Media Holdings, Inc. (a) ................... 7.75% 05/01/19 1,896,250
1,700,000 Lamar Media Corp. (a) .............................. 7.88% 04/15/18 1,865,750
1,750,000 Mediacom LLC/Mediacom Capital Corp. (a) ............ 9.13% 08/15/19 1,964,375
-------------
13,270,500
-------------
REAL ESTATE - 1.3%
1,750,000 Realogy Corp. (a) (b) .............................. 7.88% 02/15/19 1,962,188
-------------
SERVICES - 17.5%
1,650,000 AMC Entertainment, Inc. (a) ........................ 8.75% 06/01/19 1,825,313
1,750,000 Avis Budget Car Rental LLC/Avis Budget
Finance, Inc. (a) ................................ 8.25% 01/15/19 1,953,437
2,000,000 Boyd Gaming Corp. (a) (b) .......................... 9.00% 07/01/20 2,190,000
2,550,000 Casella Waste Systems, Inc. (a) .................... 7.75% 02/15/19 2,479,875
1,425,000 Cenveo Corp......................................... 8.88% 02/01/18 1,449,938
1,950,000 Chester Downs & Marina LLC (b) ..................... 9.25% 02/01/20 1,889,063
1,750,000 CityCenter Holdings LLC/CityCenter Finance
Corp. (a) ........................................ 7.63% 01/15/16 1,887,812
825,000 Iron Mountain, Inc.................................. 5.75% 08/15/24 853,875
1,750,000 MGM Resorts International (a) ...................... 7.63% 01/15/17 1,995,000
525,000 MGM Resorts International .......................... 8.63% 02/01/19 624,750
1,786,979 MTR Gaming Group, Inc............................... 11.50% 08/01/19 1,894,197
1,250,000 National Cinemedia LLC ............................. 6.00% 04/15/22 1,368,750
1,725,000 Palace Entertainment Holdings LLC/Palace
Entertainment Holdings Corp. (a) (b) ............. 8.88% 04/15/17 1,858,687
2,100,000 Pulte Group, Inc. (a) .............................. 6.38% 05/15/33 2,142,000
875,000 RSC Equipment Rental, Inc./RSC
Holdings III LLC (a) ............................. 10.25% 11/15/19 1,017,188
875,000 RSC Equipment Rental, Inc./RSC
Holdings LLC ..................................... 8.25% 02/01/21 1,001,875
-------------
26,431,760
-------------
TECHNOLOGY & ELECTRONICS - 2.6%
1,900,000 First Data Corp. (b) ............................... 11.25% 01/15/21 1,995,000
See Notes to Financial Statements Page 9
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS - (CONTINUED)
APRIL 30, 2013 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------ ---------------------------------------------------- ----------- ---------- -------------
CORPORATE BONDS AND NOTES - (CONTINUED)
TECHNOLOGY & ELECTRONICS - (CONTINUED)
$ 1,775,000 Freescale Semiconductor, Inc. (a) .................. 8.05% 02/01/20 $ 1,921,438
-------------
3,916,438
-------------
TELECOMMUNICATIONS - 7.9%
2,000,000 Centurylink, Inc. (a) .............................. 7.65% 03/15/42 2,066,090
860,000 Cincinnati Bell, Inc. (a) .......................... 8.25% 10/15/17 924,500
900,000 Cincinnati Bell, Inc. (a) .......................... 8.75% 03/15/18 922,500
375,000 Fairpoint Communications, Inc. (b) ................. 8.75% 08/15/19 382,500
1,750,000 Frontier Communications (a) ........................ 7.13% 03/15/19 1,920,625
1,875,000 MetroPCS Wireless, Inc. (b) ........................ 6.63% 04/01/23 2,022,656
1,700,000 PAETEC Holding Corp. (a) ........................... 9.88% 12/01/18 1,963,500
1,725,000 Windstream Corp. (a) ............................... 7.00% 03/15/19 1,774,594
-------------
11,976,965
-------------
UTILITY - 1.1%
1,556,000 Calpine Corp. (a) (b) .............................. 7.25% 10/15/17 1,655,195
-------------
TOTAL CORPORATE BONDS AND NOTES ............................................... 161,410,300
(Cost $149,828,516) -------------
FOREIGN CORPORATE BONDS AND NOTES - 8.8%
AUTOMOTIVE - 1.0%
1,300,000 Jaguar Land Rover PLC (b) .......................... 8.13% 05/15/21 1,495,000
-------------
BASIC INDUSTRY - 5.7%
1,540,000 Cascades, Inc. (a) ................................. 7.88% 01/15/20 1,670,900
1,150,000 FMG Resources (August 2006) Pty Ltd. (b) ........... 6.88% 04/01/22 1,237,688
1,750,000 Ineos Group Holdings Ltd. (a) (b) .................. 8.50% 02/15/16 1,781,719
1,750,000 Masonite International Corp. (a) (b) ............... 8.25% 04/15/21 1,968,750
1,775,000 Tembec Industries, Inc. (a) ........................ 11.25% 12/15/18 1,983,562
-------------
8,642,619
-------------
ENERGY - 0.8%
375,000 Petroleum Geo-Services ASA (b) ..................... 7.38% 12/15/18 419,063
645,000 Precision Drilling Corp............................. 6.63% 11/15/20 698,212
-------------
1,117,275
-------------
TECHNOLOGY & ELECTRONICS - 1.3%
1,500,000 Legrand France S.A. (a) ............................ 8.50% 02/15/25 2,019,214
-------------
TOTAL FOREIGN CORPORATE BONDS AND NOTES ....................................... 13,274,108
(Cost $12,400,832) -------------
ASSET-BACKED SECURITIES - 7.9%
Ace Securities Corp
1,120,951 Series 2003-MH1, Class A4 (b) ................... 6.50% 08/15/30 1,197,626
BankAmerica Manufactured Housing Contract
Trust II ........................................
2,300,000 Series 1997-1, Class B1 (e) ..................... 6.94% 06/10/21 2,368,944
Bombardier Capital Mortgage Securitization Corp.
285,383 Series 1999-B, Class A1B ........................ 6.61% 12/15/29 160,206
Page 10 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS - (CONTINUED)
APRIL 30, 2013 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------ ---------------------------------------------------- ----------- ---------- -------------
ASSET-BACKED SECURITIES - (CONTINUED)
Citigroup Mortgage Loan Trust, Inc.
$ 2,301,000 Series 2003-HE3, Class M4 (f) ................... 3.20% 12/25/33 $ 1,016,280
Conseco Finance Securitizations Corp.
1,859,026 Series 2000-6, Class M1 ......................... 7.72% 09/01/31 444,988
Green Tree Financial Corp.
1,036,891 Series 1996-6, Class B1 ......................... 8.00% 09/15/27 327,917
113,986 Series 1997-4, Class B1 ......................... 7.23% 02/15/29 8,529
713,196 Series 1998-4, Class M1 ......................... 6.83% 04/01/30 380,324
2,016,577 Series 1999-3, Class M1 ......................... 6.96% 02/01/31 173,861
GSAMP Trust
2,930,638 Series 2006-S5, Class A1 (f) .................... 0.29% 09/25/36 40,099
1,295,478 Series 2007-HE1, Class A2B (f) .................. 0.30% 03/25/47 1,047,692
224,154 Series 2007-NC1, Class A2A (f) .................. 0.25% 12/25/46 121,393
433,781 Series 2007-NC1, Class A2B (f) .................. 0.30% 12/25/46 236,859
2,909,947 Series 2007-NC1, Class A2C (f) .................. 0.35% 12/25/46 1,601,940
Home Equity Asset Trust
1,190,000 Series 2006-4, Class 2A4 (f) .................... 0.48% 08/25/36 894,220
IMC Home Equity Loan Trust
2,372,118 Series 1997-3, Class B .......................... 7.87% 08/20/28 1,267,646
2,456,548 Series 1997-5, Class B (g) ...................... 7.59% 11/20/28 474,503
Oakwood Mortgage Investors, Inc.
822,329 Series 1999-B, Class M1 ......................... 7.18% 12/15/26 223,768
Park Place Securities, Inc.
175,389 Series 2004-WCW2, Class M10 (f) (h) ............. 2.95% 10/25/34 517
-------------
TOTAL ASSET-BACKED SECURITIES ................................................. 11,987,312
(Cost $9,226,808) -------------
MORTGAGE-BACKED SECURITIES - 7.3%
COLLATERALIZED MORTGAGE OBLIGATIONS - 5.7%
Citicorp Mortgage Securities, Inc.
2,334,698 Series 2007-2, Class 1A3 ........................ 6.00% 02/25/37 2,463,303
Countrywide Alternative Loan Trust
244,697 Series 2006-41CB, Class 2A14 .................... 6.00% 01/25/37 210,483
196,305 Series 2007-11T1, Class A37 (f) ................. 38.82% 05/25/37 375,094
Countrywide Home Loan Mortgage Pass
Through Trust
296,627 Series 2006-21, Class A8 ........................ 5.75% 02/25/37 278,580
805,550 Series 2007-10, Class A5 ........................ 6.00% 07/25/37 738,693
HarborView Mortgage Loan Trust
2,977,846 Series 2005-9, Class B10 (e) (f) ................ 1.95% 06/20/35 93,783
MASTR Asset Securitization Trust
299,948 Series 2006-2, Class 1A10 (f) ................... 6.00% 06/25/36 298,880
Residential Accredit Loans, Inc.
204,199 Series 2007-Q56, Class A2 (f) ................... 53.92% 04/25/37 521,090
See Notes to Financial Statements Page 11
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS - (CONTINUED)
APRIL 30, 2013 (UNAUDITED)
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
------------ ---------------------------------------------------- ----------- ---------- -------------
MORTGAGE-BACKED SECURITIES - (CONTINUED)
COLLATERALIZED MORTGAGE OBLIGATIONS - (CONTINUED)
Residential Asset Securitization Trust
$ 1,206,206 Series 2005-A8CB, Class A11 ..................... 6.00% 07/25/35 $ 1,130,961
Structured Asset Securities Corp.
134,414 Series 2003-10, Class A ......................... 6.00% 04/25/33 143,032
Washington Mutual Alternative Mortgage
Pass-Through Certificates .......................
61,016 Series 2007-5, Class A11 (f) .................... 38.30% 06/25/37 110,377
Wells Fargo Mortgage Backed Securities Trust
1,129,941 Series 2006-8, Class A15 ........................ 6.00% 07/25/36 1,135,160
161,000 Series 2006-AR1, Class 2A5 (f) .................. 5.36% 03/25/36 161,360
380,976 Series 2007-7, Class A38 ........................ 6.00% 06/25/37 377,359
105,122 Series 2007-8, Class 1A16 ....................... 6.00% 07/25/37 105,218
445,561 Series 2007-8, Class 2A2 ........................ 6.00% 07/25/37 442,161
-------------
8,585,534
-------------
COMMERCIAL MORTGAGE-BACKED SECURITIES - 1.6%
Banc of America Large Loan, Inc.
1,548,035 Series 2005-MIB1, Class L (f) (g) (h) ........... 3.20% 03/15/22 291,649
Greenwich Capital Commercial Funding Corp.
1,180,000 Series 2007-GG11, Class AJ (f) .................. 6.05% 12/10/49 1,148,876
Vornado DP LLC
930,000 Series 2010-VNO, Class D (b) .................... 6.36% 09/13/28 1,078,248
-------------
2,518,773
-------------
TOTAL MORTGAGE-BACKED SECURITIES .............................................. 11,104,307
(Cost $11,002,068) -------------
SENIOR FLOATING-RATE LOAN INTERESTS - 2.1%
DIVERSIFIED TELECOMMUNICATION SERVICES - 0.6%
1,000,000 Fairpoint Communications, Inc., Term
Loan (f) ........................................ 7.50% 02/14/19 984,310
-------------
FOOD & STAPLES RETAILING - 0.4%
675,000 Albertsons, Inc. (f) ............................... 5.00% 02/27/16 682,229
-------------
HEALTHCARE - 0.7%
1,000,000 inVentiv Health, Inc., Term Loan B (f) ............. 7.50% 08/04/16 990,830
-------------
UTILITY - 0.4%
834,744 Texas Competitive Electric Holdings Co., LLC
Tranche B2 (f) .................................. 4.70%-4.79% 10/10/17 613,796
-------------
TOTAL SENIOR FLOATING-RATE LOAN INTERESTS ..................................... 3,271,165
(Cost $3,480,296) -------------
STRUCTURED NOTES - 0.0%
5,750,000 Preferred Term Securities XXV, Ltd. (h) ............ (i) 06/22/37 575
Preferred Term Securities XXVI, Ltd.
2,500,000 Subordinated Note (h) ........................... (i) 09/22/37 250
-------------
TOTAL STRUCTURED NOTES ........................................................ 825
(Cost $0) -------------
Page 12 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS - (CONTINUED)
APRIL 30, 2013 (UNAUDITED)
SHARES DESCRIPTION VALUE
------------ ------------------------------------------------------------------------------- -------------
PREFERRED SECURITIES - 0.1%
3,500 Independence III CDO, Ltd., Series 3A,
Class PS (h) (i) ............................................................ $ 3,500
4,000 Soloso CDO, Ltd., Series 2005-1 (h) (i) ....................................... 40,000
9,000 White Marlin CDO, Ltd., Series AI (h) (i) (j) ................................. 45,000
-------------
TOTAL PREFERRED SECURITIES .................................................... 88,500
(Cost $0) -------------
TOTAL INVESTMENTS - 132.8% .................................................... 201,136,517
(Cost $185,938,520) (k)
OUTSTANDING LOAN - (35.9%) .................................................... (54,400,000)
NET OTHER ASSETS AND LIABILITIES - 3.1% ....................................... 4,722,008
-------------
NET ASSETS - 100.0% ........................................................... $ 151,458,525
=============
---------------------------------------
(a) All or a portion of this security serves as collateral on the outstanding
loan.
(b) This security, sold within the terms of a private placement memorandum, is
exempt from registration upon resale under Rule 144A under the Securities
Act of 1933, as amended (the "1933 Act"), and may be resold in
transactions exempt from registration, normally to qualified institutional
buyers. Pursuant to procedures adopted by the Fund's Board of Trustees,
this security has been determined to be liquid by Brookfield Investment
Management Inc., the Fund's sub-advisor. Although market instability can
result in periods of increased overall market illiquidity, liquidity for
each security is determined based on security specific factors and
assumptions, which require subjective judgment. At April 30, 2013,
securities noted as such amounted to $38,603,196 or 25.49% of net assets.
(c) Multi-Step Coupon Bond - Coupon steps up or down based upon ratings
changes by Standard & Poor's Ratings Group or Moody's Investors Service,
Inc. The interest rate shown reflects the rate in effect at April 30,
2013.
(d) The issuer filed for bankruptcy on April 1, 2013.
(e) Security missed one or more of its interest payments.
(f) Floating rate security. The interest rate shown reflects the rate in
effect at April 30, 2013.
(g) Security is receiving less than the stated coupon.
(h) This security, sold within the terms of a private placement memorandum, is
exempt from registration upon resale under Rule 144A under the 1933 Act,
and may be resold in transactions exempt from registration, normally to
qualified institutional buyers (see Note 2C - Restricted Securities in the
Notes to Financial Statements).
(i) Zero coupon security.
(j) The issuer is in default. Income is not being accrued.
(k) Aggregate cost for financial reporting purposes, which approximates the
aggregate cost for federal income tax purposes. As of April 30, 2013, the
aggregate gross unrealized appreciation for all securities in which there
was an excess of value over tax cost was $17,279,499 and the aggregate
gross unrealized depreciation for all securities in which there was an
excess of tax cost over value was $2,081,502.
CDO Collateralized Debt Obligation
See Notes to Financial Statements Page 13
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS - (CONTINUED)
APRIL 30, 2013 (UNAUDITED)
VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of April 30,
2013 is as follows (see Note 2A - Portfolio Valuation in the Notes to Financial
Statements):
LEVEL 2 LEVEL 3
TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
4/30/2013 PRICES INPUTS INPUTS
------------- ------------ ------------- ------------
Corporate Bonds and Notes*......................... $ 161,410,300 $ -- $ 161,410,300 $ --
Foreign Corporate Bonds and Notes*................. 13,274,108 -- 13,274,108 --
Asset-Backed Securities............................ 11,987,312 -- 11,987,312 --
Mortgage-Backed Securities:
Collateralized Mortgage Obligations............ 8,585,534 -- 8,585,534 --
Commercial Mortgage-Backed Securities.......... 2,518,773 -- 2,518,773 --
Senior Floating-Rate Loan Interests*............... 3,271,165 -- 3,271,165 --
Structured Notes................................... 825 -- 825 --
Preferred Securities............................... 88,500 -- -- 88,500
------------- ------------ ------------- ------------
Total Investments.................................. $ 201,136,517 $ -- $ 201,048,017 $ 88,500
============= ============ ============= ============
* See Portfolio of Investments for industry breakout.
All transfers in and out of the Levels during the period are assumed to be
transferred on the last day of the period at their current value. There were no
transfers between Levels at April 30, 2013.
The following table presents the activity of the Fund's investments measured at
fair value on a recurring
basis using significant unobservable inputs (Level 3) for the period presented.
BEGINNING BALANCE AT OCTOBER 31, 2012
Preferred Securities $ 88,500
Net Realized Gain (Loss) --
Net Change in Unrealized Appreciation/Depreciation --
Purchases --
Sales --
Transfers In --
Transfers Out --
ENDING BALANCE AT APRIL 30, 2013
Preferred Securities 88,500
----------
Total Level 3 holdings $ 88,500
==========
There was no net change in unrealized appreciation (depreciation) from Level 3
investments held as of April 30, 2013.
Page 14 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND II
STATEMENT OF ASSETS AND LIABILITIES
APRIL 30, 2013 (UNAUDITED)
ASSETS:
Investments, at value
(Cost $185,938,520)......................................................................... $201,136,517
Cash........................................................................................... 4,517,637
Prepaid expenses............................................................................... 43,896
Interest receivable............................................................................ 3,565,352
Other assets................................................................................... 114
------------
Total Assets............................................................................. 209,263,516
------------
LIABILITIES:
Outstanding loan............................................................................... 54,400,000
Payables:
Investment securities purchased............................................................. 3,142,548
Investment advisory fees.................................................................... 150,503
Audit and tax fees.......................................................................... 42,263
Administrative fees......................................................................... 19,982
Custodian fees.............................................................................. 15,542
Printing fees............................................................................... 13,061
Transfer agent fees......................................................................... 7,236
Legal fees.................................................................................. 5,075
Interest and fees on loan................................................................... 3,874
Financial reporting fees.................................................................... 771
Other liabilities.............................................................................. 4,136
------------
Total Liabilities........................................................................ 57,804,991
------------
NET ASSETS..................................................................................... $151,458,525
============
NET ASSETS CONSIST OF:
Paid-in capital................................................................................ $204,274,226
Par value...................................................................................... 84,589
Accumulated net investment income (loss)....................................................... 2,130,149
Accumulated net realized gain (loss) on investments............................................ (70,228,436)
Net unrealized appreciation (depreciation) on investments...................................... 15,197,997
------------
NET ASSETS..................................................................................... $151,458,525
============
NET ASSET VALUE, per Common Share (par value $0.01 per Common Share)........................... $ 17.91
============
Number of Common Shares outstanding (unlimited number of Common Shares has been authorized).... 8,458,869
============
See Notes to Financial Statements Page 15
FIRST TRUST STRATEGIC HIGH INCOME FUND II
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED APRIL 30, 2013 (UNAUDITED)
INVESTMENT INCOME:
Interest....................................................................................... $ 7,755,322
------------
Total investment income..................................................................... 7,755,322
------------
EXPENSES:
Investment advisory fees....................................................................... 898,264
Interest and fees on loan...................................................................... 346,445
At the market offering costs................................................................... 128,450
Administrative fees............................................................................ 104,382
Audit and tax fees............................................................................. 38,927
Printing fees.................................................................................. 38,123
Transfer agent fees............................................................................ 19,821
Custodian fees................................................................................. 13,405
Trustees' fees and expenses.................................................................... 8,925
Legal fees..................................................................................... 7,269
Financial reporting fees....................................................................... 4,625
Other.......................................................................................... 43,990
------------
Total expenses.............................................................................. 1,652,626
------------
NET INVESTMENT INCOME (LOSS)................................................................... 6,102,696
------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on investments..................................................... 1,539,984
Net change in unrealized appreciation (depreciation) on investments......................... 5,694,196
------------
NET REALIZED AND UNREALIZED GAIN (LOSS)........................................................ 7,234,180
------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS............................... $ 13,336,876
============
Page 16 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND II
STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS
ENDED YEAR
4/30/2013 ENDED
(UNAUDITED) 10/31/2012
-------------- --------------
OPERATIONS:
Net investment income (loss)....................................................... $ 6,102,696 $ 12,821,067
Net realized gain (loss)........................................................... 1,539,984 (204,326)
Net change in unrealized appreciation (depreciation)............................... 5,694,196 7,275,057
-------------- --------------
Net increase (decrease) in net assets resulting from operations.................... 13,336,876 19,891,798
-------------- --------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income.............................................................. (6,195,267) (5,019,769)
Net realized gain.................................................................. -- --
Return of capital.................................................................. -- (7,678,703)
-------------- --------------
Total distributions to shareholders................................................ (6,195,267) (12,698,472)
-------------- --------------
CAPITAL TRANSACTIONS:
Proceeds from Common Shares sold through at the market offerings................... 112,291 5,582,406
Proceeds from Common Shares reinvested............................................. -- 319,447
Net increase (decrease) in net assets resulting from capital transactions.......... 112,291 5,901,853
-------------- --------------
Total increase (decrease) in net assets............................................ 7,253,900 13,095,179
-------------- --------------
NET ASSETS:
Beginning of period................................................................ 144,204,625 131,109,446
-------------- --------------
End of period...................................................................... $ 151,458,525 $ 144,204,625
============== ==============
Accumulated net investment income (loss) at end of period.......................... $ 2,130,149 $ 2,222,720
============== ==============
CAPITAL TRANSACTIONS WERE AS FOLLOWS:
Common Shares at beginning of period............................................... 8,452,416 8,106,875
Common Shares sold through at the market offerings................................. 6,453 326,295
Common Shares issued as reinvestment under the Dividend Reinvestment Plan.......... -- 19,246
-------------- --------------
Common Shares at end of period..................................................... 8,458,869 8,452,416
============== ==============
See Notes to Financial Statements Page 17
FIRST TRUST STRATEGIC HIGH INCOME FUND II
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED APRIL 30, 2013 (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase (decrease) in net assets resulting from operations ................... $ 13,336,876
Adjustments to reconcile net increase (decrease) in net assets resulting from
operations to net cash provided by operating activities:
Purchases of investments..................................................... (23,957,313)
Sales, maturities and paydowns of investments................................ 23,453,429
Net amortization/accretion of premiums/discounts on investments.............. (34,046)
Net realized gain/loss on investments........................................ (1,539,984)
Net change in unrealized appreciation/depreciation on investments............ (5,694,196)
Changes in assets and liabilities:
Decrease in interest receivable.............................................. 139,411
Decrease in prepaid expenses................................................. 82,855
Increase in other assets..................................................... (114)
Decrease in interest and fees on loan payable................................ (65,093)
Decrease in investment advisory fees payable................................. (716)
Decrease in audit and tax fees payable....................................... (28,572)
Decrease in legal fees payable............................................... (6,490)
Decrease in printing fees payable............................................ (13,178)
Increase in administrative fees payable...................................... 4,853
Increase in custodian fees payable........................................... 9,372
Increase in transfer agent fees payable...................................... 2,933
Decrease in Trustees' fees and expenses payable.............................. (1,957)
Decrease in other liabilities................................................ (13,386)
--------------
CASH PROVIDED BY OPERATING ACTIVITIES.............................................. $ 5,674,684
--------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds of Common Shares sold............................................... 112,291
Distributions to Common Shareholders from net investment income.............. (6,195,267)
--------------
CASH USED IN FINANCING ACTIVITIES.................................................. (6,082,976)
--------------
Decrease in cash................................................................... (408,292)
Cash at beginning of period........................................................ 4,925,929
--------------
CASH AT END OF PERIOD.............................................................. $ 4,517,637
==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest and fees.................................. $ 411,538
==============
Page 18 See Notes to Financial Statements
FIRST TRUST STRATEGIC HIGH INCOME FUND II
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD
SIX MONTHS
ENDED YEAR YEAR YEAR YEAR YEAR
4/30/2013 ENDED ENDED ENDED ENDED ENDED
(UNAUDITED) 10/31/2012 10/31/2011 10/31/2010 (a)(b) 10/31/2009 (b)(c) 10/31/2008 (b)
----------- ----------- ----------- ----------------- ----------------- --------------
Net asset value, beginning of
period ............................ $ 17.06 $ 16.17 $ 15.87 $ 14.22 $ 25.56 $ 48.93
--------- --------- --------- --------- --------- ---------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) ......... 0.72 1.52 0.59 1.86 3.87 6.12
Net realized and unrealized gain
(loss) ............................ 0.86 0.90 0.32 1.17 (11.31) (23.49)
--------- --------- --------- --------- --------- ---------
Total from investment operations ..... 1.58 2.42 0.91 3.03 (7.44) (17.37)
--------- --------- --------- --------- --------- ---------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income ................ (0.73) (0.61) (0.54) -- (0.27) (5.13)
Net realized gain .................... -- -- -- -- -- --
Return of capital .................... -- (0.94) (0.07) (1.38) (3.63) (0.87)
--------- --------- --------- --------- --------- ---------
Total from distributions to Common
Shareholders ...................... (0.73) (1.55) (0.61) (1.38) (3.90) (6.00)
--------- --------- --------- --------- --------- ---------
Premiums from shares sold in Common
Share offerings ................... 0.00 (d) 0.02 -- -- -- --
--------- --------- --------- --------- --------- ---------
Net asset value, end of period ....... $ 17.91 $ 17.06 $ 16.17 $ 15.87 $ 14.22 $ 25.56
========= ========= ========= ========= ========= =========
Market value, end of period .......... $ 17.41 $ 17.69 $ 14.51 $ 14.49 $ 13.17 $ 21.45
========= ========= ========= ========= ========= =========
TOTAL RETURN BASED ON NET ASSET
VALUE (e) ......................... 9.62% 16.11% 13.60% 23.46% (28.92)% (37.09)%
========= ========= ========= ========= ========= =========
TOTAL RETURN BASED ON MARKET
VALUE (e) ......................... 2.76% 34.16% 11.64% 21.71% (22.00)% (42.84)%
========= ========= ========= ========= ========= =========
---------------------------------------------
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period
(in 000's) ........................ $ 151,459 $ 144,205 $ 131,109 $ 50,468 $ 45,159 $ 80,740
Ratio of total expenses to average
net assets ........................ 2.27% (f) 2.52% 2.35% 2.29% 1.77% 4.09%
Ratio of total expenses to average
net assets excluding interest
expense............................ 1.79% (f) 1.93% 1.93% 2.21% 1.77% 2.45%
Ratio of net investment income (loss)
to average net assets ............. 8.38% (f) 9.52% 9.65% 12.54% 22.79% 16.48%
Portfolio turnover rate .............. 12% 33% 49% 332% (g) 147% (g) 4%
INDEBTEDNESS:
Total loan outstanding (in 000's) .... $ 54,400 $ 54,400 $ 54,400 N/A N/A N/A
Asset coverage per $1,000 of
indebtedness (h) .................. $ 3,784 $ 3,651 $ 3,410 N/A N/A N/A
---------------------------------------------
(a) On September 20, 2010, the Fund's Board of Trustees approved a new
investment management agreement with First Trust Advisors L.P. and a new
sub-advisory agreement with Brookfield Investment Management Inc.
(formerly known as Hyperion Brookfield Asset Management, Inc.)
("Brookfield"), and on December 20, 2010, the shareholders voted to
approve both agreements.
(b) All share amounts, net asset values and market values have been adjusted
as a result of the 1-for-3 reverse share split on September 30, 2011.
(c) On June 29, 2009, the Fund's Board of Trustees approved a new sub-advisory
agreement with Brookfield, and on October 14, 2009, the shareholders voted
to approve the new sub-advisory agreement with Brookfield.
(d) Amount represents less than $0.01 per share.
(e) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by
the Dividend Reinvestment Plan, and changes in net asset value per share
for net asset value returns and changes in Common Share price for market
value returns. Total returns do not reflect sales load and are not
annualized for periods less than one year. Past performance is not
indicative of future results.
(f) Annualized.
(g) For the fiscal years ended October 31, 2010 and 2009, the Fund's portfolio
turnover rate reflects mortgage pool forward commitments as purchases and
sales. This caused the reported portfolio turnover rate to be higher than
in previous fiscal years. The turnover rate may vary greatly from year to
year as well as within a year.
(h) Calculated by subtracting the Fund's total liabilities (not including the
loan outstanding) from the Fund's total assets, and dividing by the
outstanding loan balance in 000's.
N/A Not applicable.
See Notes to Financial Statements Page 19
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
1. ORGANIZATION
First Trust Strategic High Income Fund II (the "Fund") is a diversified,
closed-end management investment company organized as a Massachusetts business
trust on January 18, 2006, and is registered with the Securities and Exchange
Commission ("SEC") under the Investment Company Act of 1940, as amended (the
"1940 Act"). The Fund trades under the ticker symbol FHY on the New York Stock
Exchange ("NYSE").
The Fund's primary investment objective is to seek a high level of current
income. The Fund seeks capital growth as a secondary objective. The Fund seeks
to achieve its investment objectives by investing in a diversified portfolio of
below-investment grade and investment grade debt securities, and equity
securities that Brookfield Investment Management Inc. ("Brookfield" or the
"Sub-Advisor") believes offer attractive yield and/or capital appreciation
potential. The Fund may invest up to 100% of its Managed Assets in
below-investment grade debt securities (commonly referred to as "high-yield" or
"junk" bonds). Managed Assets means the average daily total asset value of the
Fund minus the sum of the Fund's liabilities other than the principal amount of
borrowings or reverse repurchase agreements, if any. There can be no assurance
that the Fund will achieve its investment objectives. The Fund may not be
appropriate for all investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America ("U.S. GAAP") requires
management to make estimates and assumptions that affect the reported amounts
and disclosures in the financial statements. Actual results could differ from
those estimates.
A. PORTFOLIO VALUATION:
The net asset value ("NAV") of the Common Shares of the Fund is determined
daily, as of the close of regular trading on the NYSE, normally 4:00 p.m.
Eastern time, on each day the NYSE is open for trading. If the NYSE closes early
on a valuation day, the NAV is determined as of that time. Domestic debt
securities and foreign securities are priced using data reflecting the earlier
closing of the principal markets for those securities. The NAV per Common Share
is calculated by dividing the value of all assets of the Fund (including accrued
interest and dividends), less all liabilities (including accrued expenses,
dividends declared but unpaid and any borrowings of the Fund), by the total
number of Common Shares outstanding.
The Fund's investments are valued daily in accordance with valuation procedures
adopted by the Fund's Board of Trustees and in accordance with provisions of the
1940 Act. The Fund's securities will be valued as follows:
Corporate bonds, notes, U.S. government securities, mortgage-backed
securities, asset-backed securities and other debt securities are valued
on the basis of valuations provided by dealers who make markets in such
securities or by an independent pricing service approved by the Fund's
Board of Trustees, which may use the following valuation inputs when
available:
1) benchmark yields;
2) reported trades;
3) broker/dealer quotes;
4) issuer spreads;
5) benchmark securities;
6) bids and offers; and
7) reference data including market research publications.
A ready market does not exist for some of these investments. As such,
these values may differ from the values that would have been used had a
ready market for these investments existed, and the differences could be
material.
Common stocks and other equity securities listed on any national or
foreign exchange (excluding the NASDAQ(R) Stock Market LLC ("NASDAQ") and
the London Stock Exchange Alternative Investment Market ("AIM")) are
valued at the last sale price on the exchange on which they are
principally traded or, for NASDAQ and AIM securities, the official closing
price. Securities traded on more than one securities exchange are valued
at the last sale price or official closing price, as applicable, at the
close of the securities exchange representing the principal market for
such securities.
Securities traded in an over-the-counter market are valued at their
closing bid prices.
Credit default swaps, if any, are valued using a pricing service or, if
the pricing service does not provide a value, by quotes provided by the
selling dealer or financial institution.
Debt securities having a remaining maturity of sixty days or less when
purchased are valued at cost adjusted for amortization of premiums and
accretion of discounts.
Page 20
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
In the event that the pricing service or dealer does not provide a valuation, or
the valuations received are deemed unreliable, the Fund's Board of Trustees has
designated First Trust Advisors L.P. ("First Trust") to use a fair value method
to value the Fund's securities. Additionally, if events occur after the close of
the principal markets for certain securities (e.g., domestic debt and foreign
securities) that could materially affect the Fund's NAV, First Trust may use a
fair value method to value the Fund's securities. The use of fair value pricing
is governed by valuation procedures adopted by the Fund's Board of Trustees, and
in accordance with the provisions of the 1940 Act. As a general principle, the
fair value of a security is the amount which the Fund might reasonably expect to
receive for the security upon its current sale. In light of the judgment
involved in fair valuations, there can be no assurance that a fair value
assigned to a particular security will be the amount which the Fund might be
able to receive upon its current sale. Fair valuation of a security is based on
the consideration of all available information, including, but not limited to,
the following:
1) the fundamental business data relating to the issuer;
2) an evaluation of the forces which influence the market in which
these securities are purchased and sold;
3) the type, size and cost of a security;
4) the financial statements of the issuer;
5) the credit quality and cash flow of the issuer, based on the
Sub-Advisor's or external analysis;
6) the information as to any transactions in or offers for the
security;
7) the price and extent of public trading in similar securities (or
equity securities) of the issuer/borrower, or comparable companies;
8) the coupon payments;
9) the quality, value and salability of collateral, if any, securing
the security;
10) the business prospects of the issuer, including any ability to
obtain money or resources from a parent or affiliate and an
assessment of the issuer's management;
11) the prospects for the issuer's industry, and multiples (of earnings
and/or cash flows) being paid for similar businesses in that
industry; and
12) other relevant factors.
The Fund invests a significant portion of its assets in below-investment grade
debt securities, including structured finance securities and corporate bonds.
Structured finance securities include: asset-backed securities, including home
equity, manufactured housing, etc.; commercial mortgage-backed securities;
residential mortgage-backed or private-label collateralized mortgage
obligations; and collateralized debt obligations. The value and related income
of these securities is sensitive to changes in economic conditions, including
delinquencies and/or defaults.
The Fund is subject to fair value accounting standards that define fair value,
establish the framework for measuring fair value and provide a three-level
hierarchy for fair valuation based upon the inputs to the valuation as of the
measurement date. The three levels of the fair value hierarchy are as follows:
o Level 1 - Level 1 inputs are quoted prices in active markets for
identical investments. An active market is a market in which
transactions for the investment occur with sufficient frequency and
volume to provide pricing information on an ongoing basis.
o Level 2 - Level 2 inputs are observable inputs, either directly or
indirectly, and include the following:
o Quoted prices for similar investments in active markets.
o Quoted prices for identical or similar investments in markets
that are non-active. A non-active market is a market where
there are few transactions for the investment, the prices are
not current, or price quotations vary substantially either
over time or among market makers, or in which little
information is released publicly.
o Inputs other than quoted prices that are observable for the
investment (for example, interest rates and yield curves
observable at commonly quoted intervals, volatilities,
prepayment speeds, loss severities, credit risks, and default
rates).
o Inputs that are derived principally from or corroborated by
observable market data by correlation or other means.
o Level 3 - Level 3 inputs are unobservable inputs. Unobservable
inputs may reflect the reporting entity's own assumptions about the
assumptions that market participants would use in pricing the
investment.
The inputs or methodology used for valuing investments are not necessarily an
indication of the risk associated with investing in those investments. A summary
of the inputs used to value the Fund's investments as of April 30, 2013, is
included with the Fund's Portfolio of Investments.
Page 21
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
B. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Interest income is recorded daily on the accrual basis. Amortization of premiums
and accretion of discounts are recorded using the effective interest method.
The Fund invests in certain lower credit quality securitized assets (for
example, asset-backed securities, collateralized mortgage obligations and
commercial mortgage-backed securities), as well as interest-only securities,
that have contractual cash flows. For these securities, if there is a change in
the estimated cash flows, based on an evaluation of current information, then
the estimated yield is adjusted. Additionally, if the evaluation of current
information indicates a permanent impairment of the security, the cost basis of
the security is written down and a loss is recognized. Debt obligations may be
placed on non-accrual status, and related interest income may be reduced by
ceasing current accruals and amortization/accretion and writing off interest
receivables when the collection of all or a portion of interest has become
doubtful based on consistently applied procedures. A debt obligation is removed
from non-accrual status when the issuer resumes interest payments or when
collectability of interest is reasonably assured.
Securities purchased on a when-issued, delayed-delivery or forward purchase
commitment basis may have extended settlement periods. The value of the security
so purchased is subject to market fluctuations during this period. The Fund
maintains liquid assets with a current value at least equal to the amount of its
when-issued, delayed-delivery or forward purchase commitments until payment is
made. At April 30, 2013, the Fund had no when-issued, delayed-delivery or
forward purchase commitments.
C. RESTRICTED SECURITIES:
The Fund invests in restricted securities, which are securities that may not be
offered for public sale without first being registered under the 1933 Act. Prior
to registration, restricted securities may only be resold in transactions exempt
from registration under Rule 144A under the 1933 Act, normally to qualified
institutional buyers. As of April 30, 2013, the Fund held restricted securities
as shown in the following table that the Sub-Advisor has deemed illiquid
pursuant to procedures adopted by the Fund's Board of Trustees. Although market
instability can result in periods of increased overall market illiquidity,
liquidity for each security is determined based on security-specific factors and
assumptions, which require subjective judgment. The Fund does not have the right
to demand that such securities be registered. These securities are valued
according to the valuation procedures as stated in the Portfolio Valuation note
(Note 2A) and are not expressed as a discount to the carrying value of a
comparable unrestricted security. There are no unrestricted securities with the
same maturity dates and yields for these issuers.
% OF
ACQUISITION PRINCIPAL CARRYING NET
SECURITY DATE VALUE/SHARES PRICE COST VALUE ASSETS
------------------------------------------------------------------------------------------------------------------------
Banc of America Large Loan, Inc.
Series 2005-MIB1, Class L, 3.20%, 03/15/22 06/26/06 $ 1,548,035 $ 18.84 $ 1,094,625 $ 291,649 0.19%
Independence III CDO, Ltd.
Series 3A, Class PS 4/11/06 3,500 0.00* -- 3,500 0.00**
Park Place Securities, Inc.
Series 2004-WCW2, Class M10, 2.95%, 10/25/34 03/24/06 $ 175,389 0.30 -- 517 0.00**
Preferred Term Securities XXV, Ltd.
Zero Coupon, 06/22/37 03/27/07 $ 5,750,000 0.00* -- 575 0.00**
Preferred Term Securities XXVI, Ltd.
Subordinated Note, Zero Coupon, 09/22/37 06/06/07 $ 2,500,000 0.00* -- 250 0.00**
Soloso CDO, Ltd., Series 2005-1 04/24/06 4,000 10.00 -- 40,000 0.03
White Marlin CDO, Ltd., Series AI 06/01/07 9,000 5.00 -- 45,000 0.03
------------ ---------- ------
$ 1,094,625 $ 381,491 0.25%
============ ========== ======
* Amount is less than $0.01.
** Amount is less than 0.01%.
D. INTEREST-ONLY SECURITIES:
An interest-only security ("IO Security") is the interest-only portion of a
mortgage-backed security that receives some or all of the interest portion of
the underlying mortgage-backed security and little or no principal. A reference
principal value called a notional value is used to calculate the amount of
interest due to the IO Security. IO Securities are sold at a deep discount to
their notional principal amount. Generally speaking, when interest rates are
falling and prepayment rates are increasing, the value of an IO Security will
fall. Conversely, when interest rates are rising and prepayment rates are
decreasing, generally the value of an IO Security will rise. These securities,
if any, are identified on the Portfolio of Investments.
Page 22
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
E. COLLATERALIZED DEBT OBLIGATIONS:
A collateralized debt obligation ("CDO") is an asset-backed security whose
underlying collateral is typically a portfolio of bonds or bank loans. Where the
underlying collateral is a portfolio of bonds, a CDO is referred to as a
collateralized bond obligation ("CBO"). Where the underlying collateral is a
portfolio of bank loans, a CDO is referred to as a collateralized loan
obligation ("CLO"). Investors in CDOs bear the credit risk of the underlying
collateral. Multiple tranches of securities are issued by the CDO, offering
investors various maturity and credit risk characteristics. Tranches are
categorized as senior, mezzanine, and subordinated/equity, according to their
degree of risk. If there are defaults or the CDO's collateral otherwise
underperforms, scheduled payments to senior tranches take precedence over those
of mezzanine tranches, and scheduled payments to mezzanine tranches take
precedence over those to subordinated/equity tranches. CDOs, similar to other
asset-backed securities, are subject to prepayment risk.
F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
The Fund will distribute to holders of its Common Shares monthly dividends of
all or a portion of its net income after the payment of interest and dividends
in connection with leverage, if any. Distributions will automatically be
reinvested into additional Common Shares pursuant to the Fund's Dividend
Reinvestment Plan unless cash distributions are elected by the shareholder.
Distributions from income and capital gains are determined in accordance with
income tax regulations, which may differ from U.S. GAAP. Certain capital
accounts in the financial statements are periodically adjusted for permanent
differences in order to reflect their tax character. These permanent differences
are primarily due to the varying treatment of income and gain/loss on portfolio
securities held by the Fund and have no impact on net assets or NAV per share.
Temporary differences, which arise from recognizing certain items of income,
expense and gain/loss in different periods for financial statement and tax
purposes, will reverse at some point in the future.
The tax character of distributions paid during the fiscal year ended October 31,
2012 was as follows:
Distributions paid from:
Ordinary income................................. $ 5,019,769
Capital gain.................................... --
Return of capital............................... 7,678,703
As of October 31, 2012, the distributable earnings and net assets on a tax basis
were as follows:
Undistributed ordinary income................... $ --
Undistributed capital gains..................... --
--------------
Total undistributed earnings.................... --
Accumulated capital and other losses............ (30,225,671)
Net unrealized appreciation (depreciation)...... (29,131,334)
--------------
Total accumulated earnings (losses)............. (59,357,005)
Other........................................... (684,894)
Paid-in capital................................. 204,246,524
--------------
Net assets...................................... $ 144,204,625
==============
G. INCOME TAXES:
The Fund intends to continue to qualify as a regulated investment company by
complying with the requirements under Subchapter M of the Internal Revenue Code
of 1986, as amended, which includes distributing substantially all of its net
investment income and net realized gains to shareholders. Accordingly, no
provision has been made for federal or state income taxes. However, due to the
timing and amount of distributions, the Fund may be subject to an excise tax of
4% of the amount by which approximately 98% of the Fund's taxable income exceeds
the distributions from such taxable income for the calendar year.
Under the Regulated Investment Company Modernization Act of 2010 (the "Act"),
net capital losses arising in taxable years after December 22, 2010, may be
carried forward indefinitely, and their character is retained as short-term
and/or long-term losses. Previously, net capital losses were carried forward for
up to eight years and treated as short-term losses. As a transition rule, the
Act requires that post-enactment net capital losses be used before pre-enactment
net capital losses. At October 31, 2012, the Fund had pre-enactment net capital
losses for federal income tax purposes of $30,225,671 expiring as follows:
EXPIRATION DATE AMOUNT
October 31, 2016 $ 153,970
October 31, 2017 7,674,875
October 31, 2018 15,342,938
October 31, 2019 7,053,888
Page 23
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
Of these losses, $30,191,056 are subject to loss limitation resulting from
reorganization activity. These limitations generally reduce the utilization of
these losses to a maximum of $4,318,194 per year.
During the taxable year ended October 31, 2012, the Fund utilized pre-enactment
capital loss carryforwards in the amount of $705,151.
The Fund is subject to certain limitations under the U.S. tax rules on the use
of capital loss carryforwards and net unrealized built-in losses. These
limitations apply when there has been a 50% change in ownership.
The Fund is subject to accounting standards that establish a minimum threshold
for recognizing, and a system for measuring, the benefits of a tax position
taken or expected to be taken in a tax return. Taxable years ending 2009, 2010,
2011 and 2012 remain open to federal and state audit. As of April 30, 2013,
management has evaluated the application of these standards to the Fund and has
determined that no provision for income tax is required in the Fund's financial
statements for uncertain tax positions.
H. EXPENSES:
The Fund will pay all expenses directly related to its operations.
3. INVESTMENT ADVISORY FEE, AFFILIATED TRANSACTIONS AND OTHER FEE ARRANGEMENTS
First Trust, the investment advisor to the Fund, is a limited partnership with
one limited partner, Grace Partners of DuPage L.P., and one general partner, The
Charger Corporation. The Charger Corporation is an Illinois corporation
controlled by James A. Bowen, Chief Executive Officer of First Trust. First
Trust is responsible for the ongoing monitoring of the Fund's investment
portfolio, managing the Fund's business affairs and providing certain
administrative services necessary for the management of the Fund. For these
investment management services, First Trust is entitled to a monthly fee
calculated at an annual rate of 0.90% of the Fund's Managed Assets. First Trust
also provides fund reporting services to the Fund for a flat annual fee in the
amount of $9,250.
Brookfield serves as the Fund's sub-advisor and manages the Fund's portfolio
subject to First Trust's supervision. The Sub-Advisor receives a portfolio
management fee at an annual rate of 0.45% of Managed Assets that is paid by
First Trust from its investment advisory fee.
BNY Mellon Investment Servicing (US) Inc. ("BNYM IS") serves as the Fund's
administrator, fund accountant and transfer agent in accordance with certain fee
arrangements. As administrator and fund accountant, BNYM IS is responsible for
providing certain administrative and accounting services to the Fund, including
maintaining the Fund's books of account, records of the Fund's securities
transactions, and certain other books and records. As transfer agent, BNYM IS is
responsible for maintaining shareholder records for the Fund. The Bank of New
York Mellon ("BNYM") serves as the Fund's custodian in accordance with certain
fee arrangements. As custodian, BNYM is responsible for custody of the Fund's
assets.
Each Trustee who is not an officer or employee of First Trust, any sub-advisor
or any of their affiliates ("Independent Trustees") is paid a fixed annual
retainer of $125,000 per year and an annual per fund fee of $4,000 for each
closed-end fund or other actively managed fund and $1,000 for each index fund in
the First Trust Fund Complex. The fixed annual retainer is allocated pro rata
among each fund in the First Trust Fund Complex based on net assets.
Additionally, the Lead Independent Trustee is paid $15,000 annually, the
Chairman of the Audit Committee is paid $10,000 annually, and each of the
Chairmen of the Nominating and Governance Committee and the Valuation Committee
is paid $5,000 annually to serve in such capacities, with such compensation
allocated pro rata among each fund in the First Trust Fund Complex based on net
assets. Trustees are reimbursed for travel and out-of-pocket expenses in
connection with all meetings. The Lead Independent Trustee and each Committee
chairman will serve two-year terms until December 31, 2013 before rotating to
serve as chairman of another committee or as Lead Independent Trustee. After
December 31, 2013, the Lead Independent Trustee and Committee Chairmen will
rotate every three years. The officers and "Interested" Trustee receive no
compensation from the funds for acting in such capacities.
4. PURCHASES AND SALES OF SECURITIES
The cost of purchases and proceeds from sales of securities, excluding
short-term investments, for the six months ended April 30, 2013, were
$27,099,861 and $23,453,429, respectively.
5. BORROWINGS
The Fund entered into a committed facility agreement with BNP Paribas Prime
Brokerage Inc. ("BNP") that has a maximum commitment amount of $66,000,000.
Absent certain events of default or failure to maintain certain collateral
requirements, BNP may not terminate the committed facility agreement except upon
180 calendar days' prior notice. The borrowing rate under the facility is equal
to the 3-month LIBOR plus 100 basis points. In addition, under the facility, the
Fund pays a commitment fee of 0.80% on the undrawn amount of such facility.
Page 24
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
The average amount outstanding for the six months ended April 30, 2013 was
$54,400,000, with a weighted average interest rate of 1.10%. As of April 30,
2013, the Fund had outstanding borrowings of $54,400,000 under this committed
facility agreement. The high and low annual interest rates for the six months
ended April 30, 2013 were 1.11% and 1.08%, respectively. The interest rate at
April 30, 2013 was 1.08%.
6. COMMON SHARE OFFERINGS
On June 8, 2012, the Fund, Advisor and Sub-Advisor entered into a sales
agreement with JonesTrading Institutional Services, LLC ("JonesTrading") whereby
the Fund may offer and sell up to 1,000,000 Common Shares from time to time
through JonesTrading as agent for the offer and sale of the Common Shares. Sales
of Common Shares pursuant to the sales agreement may be made in negotiated
transactions or transactions that are deemed to be "at the market" as defined in
Rule 415 under the Securities Act of 1933, as amended, including sales made
directly on the NYSE or sales made through a market maker other than on an
exchange, at an offering price equal to or in excess of the net asset value per
share of the Fund's Common Shares at the time such Common Shares are initially
sold. The Fund intends to use the net proceeds from the sale of the Common
Shares in accordance with its investment objectives and policies. Sales of
Common Shares made under the sales agreement will be made pursuant to a "shelf"
registration statement on Form N-2 (the "Registration Statement") that will
require the Fund to obtain effectiveness from the SEC on an annual basis. The
Registration Statement has not been effective since February 2013 and therefore
Common Shares have not been offered under the sales agreement since that time.
Any future sales of Common Shares under the sales agreement will be made
pursuant to an effective Registration Statement. Transactions related to
offerings under such sales agreement are as follows:
COMMON NET PROCEEDS
SHARES NET PROCEEDS NET ASSET VALUE RECEIVED IN
SOLD RECEIVED OF SHARES SOLD EXCESS OF NET ASSET VALUE
---------- ------------ --------------- -------------------------
Six Months Ended 4/30/13 6,453 $ 112,291 $ 109,427 $ 2,864
Year Ended 10/31/12 326,295 5,582,406 5,436,347 146,059
7. INDEMNIFICATION
The Fund has a variety of indemnification obligations under contracts with its
service providers. The Fund's maximum exposure under these arrangements is
unknown. However, the Fund has not had prior claims or losses pursuant to these
contracts and expects the risk of loss to be remote.
8. LITIGATION
Lehman Brothers Special Finance, Inc. ("LBSF") is maintaining a certain class
action in the United States Bankruptcy Court for the Southern District of New
York (the "Class Litigation"), seeking to recover funds that it alleges were
inappropriately distributed to counter-parties upon the termination of credit
swap agreements based on Lehman Brothers' bankruptcy. The Class Litigation was
filed September 14, 2010. The Class Litigation names the issuers of certain
asset-backed securities (the "Issuer Defendants"), the trustees for such
securities (the "Trustee Defendants") and certain of the investors in the
securities (the "Named Noteholder Defendants"). On July 11, 2012, special
counsel for LBSF filed a motion in the United States Bankruptcy Court for the
Southern District of New York to add additional Named Noteholder Defendants,
including the Fund and two funds (First Trust Strategic High Income Fund and
First Trust Strategic High Income Fund III) subsequently reorganized into the
Fund in the Class Litigation. On July 18, 2012, the court granted the motion to
add the Named Noteholder Defendants, including the Fund. The Court in the Class
Litigation entered an order on February 15, 2013 imposing a stay in the action
until July 20, 2013.
The Fund has been advised that it, First Trust Strategic High Income Fund and
First Trust Strategic High Income Fund III received, in the aggregate,
$6,750,000 from one Issuer Defendant. Based on the current status of the Class
Litigation, the Fund cannot predict the outcome of the Class Litigation at this
time.
9. RISK CONSIDERATIONS
Risks are inherent in all investing. The following summarizes some of the risks
that should be considered for the Fund. For additional information about the
risks associated with investing in the Fund, please see the Fund's prospectus
and statement of additional information, as well as other Fund regulatory
filings.
INVESTMENT AND MARKET RISK: An investment in the Fund's Common Shares is subject
to investment risk, including the possible loss of the entire principal
invested. An investment in Common Shares represents an indirect investment in
the securities owned by the Fund. The value of these securities, like other
market investments, may move up or down, sometimes rapidly and unpredictably.
Common Shares at any point in time may be worth less than the original
investment, even after taking into account the reinvestment of Fund dividends
and distributions. Security prices can fluctuate for several reasons including
the general condition of the securities markets, or when political or economic
events affecting the issuers occur, including the risk that borrowers do not pay
their mortgages. When the Advisor or Sub-
Page 25
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
Advisor determines that it is temporarily unable to follow the Fund's investment
strategy or that it is impractical to do so (such as when a market disruption
event has occurred and trading in the securities is extremely limited or
absent), the Advisor or Sub-Advisor may take temporary defensive positions.
RESIDENTIAL MORTGAGE-BACKED SECURITIES RISK: MBS's may have less potential for
capital appreciation than comparable fixed-income securities due to the
likelihood of increased prepayments of mortgages as interest rates decline. If
the Fund buys MBS's at a premium, mortgage foreclosures and prepayments of
principal by mortgagors (which usually may be made at any time without penalty)
may result in some loss of the Fund's principal investment to the extent of the
premium paid. Alternatively, in a rising interest rate environment, the value of
MBS's may be adversely affected when payments on underlying mortgages do not
occur as anticipated, resulting in the extension of the security's effective
maturity and the related increase in interest rate sensitivity of a longer-term
instrument. The value of MBS's may also change due to shifts in the market's
perception of issuers and regulatory or tax changes adversely affecting the
markets as a whole. In addition, MBS's are subject to the credit risk associated
with the performance of the underlying mortgage properties. In certain
instances, third-party guarantees or other forms of credit support can reduce
the credit risk. The Fund may also invest in MBS's which are interest-only
securities ("IO") and principal-only ("PO") securities. Generally speaking, when
interest rates are falling and prepayment rates are increasing, the value of a
PO security will rise and the value of an IO security will fall. Conversely,
when interest rates are rising and prepayment rates are decreasing, generally
the value of a PO will fall and the value of an IO security will rise. In
addition to the foregoing, residential MBS's are subject to additional risks,
including, but not limited to: (i) the United States residential mortgage market
has recently encountered various difficulties and changed economic conditions.
In addition, recently, residential property values in various states have
declined or remained stable after extended periods of appreciation. A continued
decline or an extended flattening in those values may result in additional
increases in delinquencies and losses on residential mortgage loans generally;
(ii) if a residential mortgage obligation is secured by a junior lien it will be
subordinate to the rights of the mortgagees or beneficiaries under the related
senior mortgages or deeds of trust; and (iii) depending on the length of a
residential mortgage obligation underling a residential MBS, unscheduled or
early payments of principal and interest may shorten the security's effective
maturity and prevailing interest rates may be higher or lower than the current
yield of the Fund's portfolio at the time the Fund receives the payments for
reinvestment.
VALUE INVESTING RISK: The Sub-Advisor focuses the Fund's investments on
securities that they believe are undervalued or inexpensive relative to other
investments. Such securities are subject to the risk of misestimating certain
fundamental factors. Disciplined adherence to a "value" investment mandate
during periods in which that style is "out of favor" can result in significant
underperformance relative to overall market indices and other managed investment
vehicles that pursue growth style investments and/or flexible style mandates.
BELOW-INVESTMENT GRADE SECURITIES RISK: The Fund invests in below-investment
grade securities. The market values for high-yield securities tend to be very
volatile, and these securities are less liquid than investment grade debt
securities. For these reasons, an investment in the Fund is subject to the
following specific risks: (a) increased price sensitivity to changing interest
rates and to a deteriorating economic environment; (b) greater risk of loss due
to default or declining credit quality; (c) adverse issuer specific events are
more likely to render the issuer unable to make interest and/or principal
payments; and (d) a negative perception of the high-yield market may depress the
price and liquidity of high-yield securities.
DISTRESSED SECURITIES RISK: The Fund may invest in securities issued by
companies in a bankruptcy reorganization proceeding, subject to some other form
of a public or private debt restructuring or otherwise in default or in
significant risk of default in the payment of interest or repayment of principal
or trading at prices substantially below other below-investment grade debt
securities of companies in similar industries. Distressed securities frequently
do not produce income while they are outstanding. The Fund may be required to
incur certain extraordinary expenses in order to protect and recover its
investment. Therefore, to the extent the Sub-Advisor seeks capital appreciation
through investment in distressed securities; the ability to achieve current
income may be diminished.
ECONOMIC CONDITIONS RISK: Adverse changes in economic conditions are more likely
to lead to a weakened capacity of a high-yield issuer to make principal payments
and interest payments than an investment grade issuer. An economic downturn
could severely affect the ability of highly leveraged issuers to service their
debt obligations or to repay their obligations upon maturity. Under adverse
market or economic conditions, the secondary market for high-yield securities
could contract further, independent of any specific adverse changes in the
condition of a particular issuer and these securities may become illiquid. As a
result, the Sub-Advisor could find it more difficult to sell these securities or
may be able to sell the securities only at prices lower than if such securities
were widely traded.
FIXED-INCOME SECURITIES RISK: Debt securities, including high yield securities,
are subject to certain risks, including: (i) issuer risk, which is the risk that
the value of fixed-income securities may decline for a number of reasons which
directly relate to the issuer, such as management performance, financial
leverage and reduced demand for the issuer's goods and services or, in the case
of asset-backed issuers, a decline in the value and/or cash flows of the
underlying assets; (ii) reinvestment risk, which is the risk that income from
the Fund's portfolio will decline if the proceeds from matured, traded or called
bonds are reinvested at market interest rates that are below the portfolio's
current earnings rate; (iii) prepayment risk, which is the risk that during
periods of declining interest rates, the issuer of a security may exercise its
option to prepay principal earlier than scheduled, forcing the reinvestment in
lower yielding securities; and (iv) credit risk, which is the risk that a
security in the Fund's portfolio will decline in price or the issuer fails to
make interest payments when due because the issuer of the security experiences a
decline in its financial status.
Page 26
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
INTEREST RATE RISK: The Fund's portfolio is also subject to interest rate risk.
Interest rate risk is the risk that fixed-income securities will decline in
value because of changes in market interest rates. Investments in debt
securities with long-term maturities may experience significant price declines
if long-term interest rates increase.
LEVERAGE RISK: The Fund may borrow an amount up to 33-1/3% (or such other
percentage as permitted by law) of its assets (including the amount borrowed)
less liabilities other than borrowings. The Fund may use leverage for investment
purposes and to meet cash requirements. Its leveraged capital structure creates
special risks not associated with unleveraged funds having similar investment
objectives and policies. These include the possibility of higher volatility of
the NAV of the Fund. The Fund previously leveraged its assets through the use of
reverse repurchase agreements. Reverse repurchase agreements are subject to the
risks that the market value of the securities sold by the Fund may decline below
the price of the securities the Fund is obligated to repurchase, and that the
securities may not be returned to the Fund. The Fund may from time to time
consider changing the amount of the leverage in response to actual or
anticipated changes in interest rates or the value of the Fund's investment
portfolio. There can be no assurance that the leverage strategies will be
successful.
FOREIGN SECURITIES RISK: The Fund may invest in securities (equity or debt) of
foreign issuers. Investing in securities of foreign issuers, which are generally
denominated in foreign currencies, may involve certain risks not typically
associated with investing in securities of U.S. issuers. These risks include:
(i) there may be less publicly available information about foreign issuers or
markets due to less rigorous disclosure or accounting standards or regulatory
practices; (ii) foreign markets may be smaller, less liquid and more volatile
than the U.S. market; (iii) potential adverse effects of fluctuations in
currency exchange rates or controls on the value of the Fund's investments; (iv)
the economies of foreign countries may grow at slower rates than expected or may
experience a downturn or recession; (v) the impact of economic, political,
social or diplomatic events; (vi) certain foreign countries may impose
restrictions on the ability of foreign issuers to make payments of principal and
interest to investors located in the United States due to blockage of foreign
currency exchanges or otherwise; and (vii) withholding and other foreign taxes
may decrease the Fund's return. These risks may be more pronounced to the extent
that the Fund invests a significant amount of its assets in companies located in
one region and to the extent that the Fund invests in securities of issuers in
emerging markets.
10. SUBSEQUENT EVENTS
Management has evaluated the impact of all subsequent events to the Fund through
the date the financial statements were issued, and has determined that there
were the following subsequent events:
On May 20, 2013, the Fund declared a dividend of $0.1200 per share to Common
Shareholders of record on June 5, 2013, payable June 17, 2013.
On June 20, 2013, the Fund declared a dividend of $0.1200 per share to Common
Shareholders of record on July 3, 2013, payable July 15, 2013.
Page 27
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Shares will be automatically reinvested by BNY
Mellon Investment Servicing (US) Inc. (the "Plan Agent"), in additional Common
Shares under the Plan. If you elect to receive cash distributions, you will
receive all distributions in cash paid by check mailed directly to you by the
Plan Agent, as the dividend paying agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
(1) If Common Shares are trading at or above net asset value ("NAV") at
the time of valuation, the Fund will issue new shares at a price
equal to the greater of (i) NAV per Common Share on that date or
(ii) 95% of the market price on that date.
(2) If Common Shares are trading below NAV at the time of valuation, the
Plan Agent will receive the dividend or distribution in cash and
will purchase Common Shares in the open market, on the NYSE or
elsewhere, for the participants' accounts. It is possible that the
market price for the Common Shares may increase before the Plan
Agent has completed its purchases. Therefore, the average purchase
price per share paid by the Plan Agent may exceed the market price
at the time of valuation, resulting in the purchase of fewer shares
than if the dividend or distribution had been paid in Common Shares
issued by the Fund. The Plan Agent will use all dividends and
distributions received in cash to purchase Common Shares in the open
market within 30 days of the valuation date except where temporary
curtailment or suspension of purchases is necessary to comply with
federal securities laws. Interest will not be paid on any uninvested
cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (866) 340-1104, in
accordance with such reasonable requirements as the Plan Agent and the Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan, and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing BNY Mellon Investment
Servicing (US) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809.
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how
to vote proxies and information on how the Fund voted proxies relating to
portfolio investments during the most recent 12-month period ended June 30 is
available (1) without charge, upon request, by calling (800) 988-5891; (2) on
the Fund's website located at http://www.ftportfolios.com; and (3) on the
Securities and Exchange Commission's ("SEC") website located at
http://www.sec.gov.
Page 28
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2013 (UNAUDITED)
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the SEC for the
first and third quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q
are available (1) by calling (800) 988-5891; (2) on the Fund's website located
at http://www.ftportfolios.com; (3) on the SEC's website at http://www.sec.gov;
and (4) for review and copying at the SEC's Public Reference Room ("PRR") in
Washington, DC. Information regarding the operation of the PRR may be obtained
by calling (800) SEC-0330.
SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
The Joint Annual Meeting of Shareholders of the Common Shares of Macquarie/First
Trust Global Infrastructure/Utilities Dividend & Income Fund, First Trust Energy
Income and Growth Fund, First Trust Enhanced Equity Income Fund, First
Trust/Aberdeen Global Opportunity Income Fund, First Trust Mortgage Income Fund,
First Trust Strategic High Income Fund II, First Trust/Aberdeen Emerging
Opportunity Fund, First Trust Specialty Finance and Financial Opportunities
Fund, First Trust Active Dividend Income Fund, First Trust High Income
Long/Short Fund and First Trust Energy Infrastructure Fund, was held on April
17, 2013 (the "Annual Meeting"). At the Annual Meeting, Trustees James A. Bowen
and Niel B. Nielson were elected by the Common Shareholders of the First Trust
Strategic High Income Fund II as Class III Trustees for three-year terms
expiring at the Fund's annual meeting of shareholders in 2016. The number of
votes cast in favor of Mr. Bowen was 7,083,334, the number of votes against was
180,891 and the number of abstentions was 1,194,644. The number of votes cast in
favor of Mr. Nielson was 7,106,027, the number against was 158,198 and the
number of abstentions was 1,194,644. Richard E. Erickson, Thomas R. Kadlec and
Robert F. Keith are the other current and continuing Trustees.
Page 29
This Page Left Blank Intentionally.
This Page Left Blank Intentionally.
This Page Left Blank Intentionally.
FIRST TRUST
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 E. Liberty Drive, Suite 400
Wheaton, IL 60187
INVESTMENT SUB-ADVISOR
Brookfield Investment Management Inc.
3 World Financial Center
200 Vesey Street, 10th Floor
New York, NY 10281
ADMINISTRATOR,
FUND ACCOUNTANT &
TRANSFER AGENT
BNY Mellon Investment Servicing (US) Inc.
301 Bellevue Parkway
Wilmington, DE 19809
CUSTODIAN
The Bank of New York Mellon
101 Barclay Street, 20th Floor
New York, NY 10286
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
111 S. Wacker Drive
Chicago, IL 60606
LEGAL COUNSEL
Chapman and Cutler LLP
111 W. Monroe Street
Chicago, IL 60603
[BLANK BACK COVER]
ITEM 2. CODE OF ETHICS.
Not applicable.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
Not applicable.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to
shareholders filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Not applicable.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
There has been no change, as of the date of this filing, in any of the
portfolios managers identified in response to paragraph (a)(1) of this Item in
the Registrant's most recently filed annual report on Form N-CSR.
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.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers, or
persons performing similar functions, have concluded that the registrant's
disclosure controls and procedures (as defined in Rule 30a-3(c) under the
Investment Company Act of 1940, as amended (the "1940 Act") (17 CFR
270.30a-3(c))) are effective, as of a date within 90 days of the filing
date of the report that includes the disclosure required by this
paragraph, based on their evaluation of these controls and procedures
required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and
Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as
amended (17 CFR 240.13a-15(b) or 240.15d-15(b)).
(b) There were no changes in the registrant's internal control over financial
reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR
270.30a-3(d)) that occurred during the registrant's second fiscal quarter
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.
(a)(1) Not applicable.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes- Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) First Trust Strategic High Income Fund II
-------------------------------------------------
By (Signature and Title)* /s/ Mark R. Bradley
----------------------------------------
Mark R. Bradley, President and
Chief Executive Officer
(principal executive officer)
Date: June 18, 2013
------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ Mark R. Bradley
----------------------------------------
Mark R. Bradley, President and
Chief Executive Officer
(principal executive officer)
Date: June 18, 2013
------------------
By (Signature and Title)* /s/ James M. Dykas
----------------------------------------
James M. Dykas, Treasurer,
Chief Financial Officer and
Chief Accounting Officer
(principal financial officer)
Date: June 18, 2013
------------------
* Print the name and title of each signing officer under his or her signature.