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 811-22245
-----------
First Trust Exchange-Traded Fund III
---------------------------------------------------------
(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: October 31, 2015
------------------
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW,
Washington, DC 20549-0609. The OMB has reviewed this collection of information
under the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORT TO STOCKHOLDERS.
The registrant's annual report transmitted to shareholders pursuant to Rule
30e-1 under the Investment Company Act of 1940 is as follows:
FIRST TRUST
First Trust Exchange-Traded Fund III
------------------------------------
First Trust Preferred Securities and Income ETF (FPE)
Annual Report
For the
Year Ended
October 31, 2015
--------------------------------------------------------------------------------
TABLE OF CONTENTS
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
ANNUAL REPORT
OCTOBER 31, 2015
Shareholder Letter......................................................... 1
Fund Performance Overview.................................................. 2
Portfolio Commentary....................................................... 5
Understanding Your Fund Expenses........................................... 7
Portfolio of Investments................................................... 8
Statement of Assets and Liabilities........................................ 14
Statement of Operations.................................................... 15
Statements of Changes in Net Assets........................................ 16
Financial Highlights....................................................... 17
Notes to Financial Statements.............................................. 18
Report of Independent Registered Public Accounting Firm ................... 24
Additional Information .................................................... 25
Board of Trustees and Officers ............................................ 27
Privacy Policy ............................................................ 29
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 Stonebridge Advisors LLC ("Stonebridge" 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
the series of First Trust Exchange-Traded Fund III (the "Trust") described in
this report for the First Trust Preferred Securities and Income ETF (hereinafter
referred to as 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 objective. 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 Additional
Information section of this report 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 share price will fluctuate and Fund shares, when
sold, may be worth more or less than their original cost.
The Advisor may also periodically provide additional information on Fund
performance on the Fund's webpage at http://www.ftportfolios.com.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment in
the Fund. It includes details about the Fund's portfolio and presents data and
analysis that provide insight into the Fund's performance and investment
approach.
By reading the portfolio commentary from 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 the
Advisor or Sub-Advisor 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 material risks of
investing in the Fund are spelled out in its prospectus, statement of additional
information, this report and other Fund regulatory filings.
--------------------------------------------------------------------------------
SHAREHOLDER LETTER
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
ANNUAL LETTER FROM THE CHAIRMAN AND CEO
OCTOBER 31, 2015
Dear Shareholders:
Thank you for your investment in First Trust Preferred Securities and Income ETF
(the "Fund").
First Trust Advisors L.P. ("First Trust") is pleased to provide you with the
annual report which contains detailed information about your investment for the
12 months ended October 31, 2015, including a market overview and a performance
analysis for the period. We encourage you to read this report and discuss it
with your financial advisor.
U.S. markets, fueled by accelerating growth and an accommodating Federal
Reserve, enjoyed a prosperous year in 2014. However, most of 2015 has been
volatile. Economic and global factors, such as the continued conflict in the
Middle East, a sharp decline in oil prices and terrorism around the world, have
impacted U.S. and global markets. Another factor that has weighed upon U.S.
markets for most of the year is the fact that many economists had predicted that
the Federal Reserve would begin to raise interest rates in 2015, which has still
not happened.
As I have written previously, First Trust believes investors should maintain
perspective about the markets and have realistic expectations about their
investments. Markets will always go up and down, but we believe that having a
long-term investment horizon and being invested in quality products can help you
reach your goals.
Thank you for giving First Trust the opportunity to be a part of your investment
plan. We value the relationship and will continue to focus on our disciplined
investment approach and long-term perspective to help investors reach their
financial goals.
Sincerely,
/s/ James A. Bowen
James A. Bowen
Chairman of the Board of Trustees
Chief Executive Officer of First Trust Advisors L.P.
Page 1
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
First Trust Preferred Securities and Income ETF's (the "Fund") investment
objective is to seek total return and to provide current income. Under normal
market conditions, the Fund invests at least 80% of its net assets (including
investment borrowings) in preferred securities ("Preferred Securities") and
income-producing debt securities ("Income Securities"). The Fund invests in
securities that are traded over-the-counter or listed on an exchange. For
purposes of the 80% test set forth above, securities of open-end funds,
closed-end funds or other exchange-traded funds ("ETFs") registered under the
Investment Company Act of 1940, as amended, that invest primarily in Preferred
Securities or Income Securities are deemed to be Preferred Securities or Income
Securities.
Preferred Securities held by the Fund generally pay fixed or adjustable-rate
distributions to investors and have preference over common stock in the payment
of distributions and the liquidation of a company's assets, but are generally
junior to all forms of the company's debt, including both senior and
subordinated debt. Certain of the Preferred Securities may be issued by trusts
or other special purpose entities created by companies specifically for the
purpose of issuing such securities. Income Securities that may be held by the
Fund include corporate bonds, high yield securities (commonly referred to as
"junk" bonds) and convertible securities. The broad category of corporate debt
securities includes debt issued by U.S. and non-U.S. companies of all kinds,
including those with small, mid and large capitalizations. Corporate debt may
carry fixed or floating rates of interest.
-------------------------------------------------------------------------------------------------------------------
PERFORMANCE
-------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL CUMULATIVE
1 Year TOTAL RETURNS TOTAL RETURNS
Ended Inception (2/11/13) Inception (2/11/13)
10/31/15 to 10/31/15 to 10/31/15
FUND PERFORMANCE
NAV 5.75% 3.59% 10.06%
Market Price 5.96% 3.69% 10.35%
INDEX PERFORMANCE
BofA Merrill Lynch Fixed Rate Preferred Securities Index 7.50% 5.79% 16.53%
BofA Merrill Lynch U.S. Capital Securities Index 1.60% 5.43% 15.44%
Blended Index(1) 4.52% 5.63% 16.04%
-------------------------------------------------------------------------------------------------------------------
Total returns for the period since inception are calculated from the inception
date of the Fund. "Average Annual Total Returns" represent the average annual
change in value of an investment over the periods indicated. "Cumulative Total
Returns" represent the total change in value of an investment over the periods
indicated.
The Fund's per share net asset value ("NAV") is the value of one share of the
Fund and is computed by dividing the value of all assets of the Fund (including
accrued interest and dividends), less all liabilities (including accrued
expenses and dividends declared but unpaid), by the total number of outstanding
shares. The price used to calculate market return ("Market Price") is determined
by using the midpoint between the highest bid and the lowest offer on the stock
exchange on which shares of the Fund are listed for trading as of the time that
the Fund's NAV is calculated. Since shares of the Fund did not trade in the
secondary market until after its inception, for the period from inception to the
first day of secondary market trading in shares of the Fund, the NAV of the Fund
is used as a proxy for the secondary market trading price to calculate market
returns. NAV and market returns assume that all distributions have been
reinvested in the Fund at NAV and Market Price, respectively.
An index is a statistical composite that tracks a specified financial market or
sector. Unlike the Fund, the indexes do not actually hold a portfolio of
securities and therefore do not incur the expenses incurred by the Fund. These
expenses negatively impact the performance of the Fund. Also, market returns do
not include brokerage commissions that may be payable on secondary market
transactions. If brokerage commissions were included, market returns would be
lower. The total returns presented reflect the reinvestment of dividends on
securities in the index. The returns presented do not reflect the deduction of
taxes that a shareholder would pay on Fund distributions or the redemption or
sale of Fund shares. The investment return and principal value of shares of the
Fund will vary with changes in market conditions. Shares of the Fund may be
worth more or less than their original cost when they are redeemed or sold in
the market. The Fund's past performance is no guarantee of future performance.
(1) The Blended Index consists of a 50/50 blend of the BofA Merrill Lynch
Fixed Rate Preferred Securities Index and the BofA Merrill Lynch U.S.
Capital Securities Index. The Blended Index was added to reflect the
diverse allocation of institutional preferred and hybrid securities in the
Fund's portfolio. The indexes do not charge management fees or brokerage
expenses, and no such fees or expenses were deducted from the performance
shown. Indexes are unmanaged and an investor cannot invest directly in an
index.
Page 2
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
-----------------------------------------------------
% OF TOTAL
PORTFOLIO SECTOR ALLOCATION INVESTMENTS
-----------------------------------------------------
Financials 83.9%
Consumer Staples 6.1
Utilities 4.8
Telecommunication Services 2.6
Materials 2.0
Energy 0.6
------
Total 100.0%
======
-----------------------------------------------------
% OF TOTAL
CREDIT RATING(2) INVESTMENTS
-----------------------------------------------------
A+ 0.8%
A 0.1
A- 4.7
BBB+ 10.0
BBB 10.2
BBB- 23.7
BB+ 14.9
BB 10.5
BB- 9.6
B+ 4.8
B 1.7
Not Rated 9.0
------
Total 100.0%
======
-----------------------------------------------------
% OF TOTAL
TOP TEN HOLDINGS INVESTMENTS
-----------------------------------------------------
CHS, Inc., Series 2 2.6%
First Niagara Financial Group., Inc.,
Series B 2.6
GMAC Capital Trust I, Series 2 2.6
Morgan Stanley, Series F 2.3
Goldman Sachs Group, Inc., Series K 2.3
Citigroup Capital XIII 2.2
Endurance Specialty Holdings Ltd.,
Series A 2.0
Aviva PLC 1.9
Aspen Insurance Holdings Ltd. 1.9
VEREIT, Inc., Series F 1.7
------
Total 22.1%
======
-----------------------------------------------------
% OF TOTAL
COUNTRY EXPOSURE INVESTMENTS
-----------------------------------------------------
United States 62.6%
Bermuda 8.4
France 6.7
United Kingdom 5.7
Netherlands 5.7
Australia 2.0
Ireland 1.9
Italy 1.5
Luxembourg 1.3
Spain 1.0
Switzerland 0.8
Chile 0.7
Japan 0.6
Cayman Islands 0.5
Belgium 0.3
Brazil 0.3
------
Total 100.0%
======
(2) 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
creditworthiness of the issuers of the underlying securities in the Fund,
and not to the Fund or its shares. Credit ratings are subject to change.
Page 3
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
PERFORMANCE OF A $10,000 INITIAL INVESTMENT
FEBRUARY 11, 2013 - OCTOBER 31, 2015
First Trust Preferred BofA Merrill Lynch Fixed BofA Merrill Lynch U.S. Blended
Securities and Income ETF Rate Preferred Securities Index Capital Securities Index Index(1)
2/11/13 $10,000 $10,000 $10,000 $10,000
4/30/13 10,330 10,253 10,342 10,297
10/31/13 9,426 9,640 10,392 10,010
4/30/14 10,084 10,418 10,992 10,704
10/31/14 10,409 10,841 11,364 11,102
04/30/15 10,810 11,326 11,766 11,547
10/31/15 11,007 11,653 11,546 11,604
Performance figures assume reinvestment of all distributions and do not reflect
the deduction of taxes that a shareholder would pay on Fund distributions or the
redemption or sale of Fund shares. An index is a statistical composite that
tracks a specified financial market or sector. Unlike the Fund, the indices do
not actually hold a portfolio of securities and therefore do not incur the
expenses incurred by the Fund. These expenses negatively impact the performance
of the Fund. The Fund's past performance does not predict future performance.
FREQUENCY DISTRIBUTION OF DISCOUNTS AND PREMIUMS
BID/ASK MIDPOINT VS. NAV THROUGH OCTOBER 31, 2015
The following Frequency Distribution of Discounts and Premiums charts are
provided to show the frequency at which the bid/ask midpoint price for the Fund
was at a discount or premium to the daily NAV. The following tables are for
comparative purposes only and represent the period February 12, 2013
(commencement of trading) through October 31, 2015. Shareholders may pay more
than NAV when they buy Fund shares and receive less than NAV when they sell
those shares because shares are bought and sold at current market price. Data
presented represents past performance and cannot be used to predict future
results.
------------------------------------------------------------------------------
NUMBER OF DAYS BID/ASK MIDPOINT AT/ABOVE NAV
------------------------------------------------------------------------------
FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00%
2/12/13 - 10/31/13 96 7 0 0
11/1/13 - 10/31/14 140 2 0 0
11/1/14 - 10/31/15 214 16 0 0
------------------------------------------------------------------------------
NUMBER OF DAYS BID/ASK MIDPOINT BELOW NAV
------------------------------------------------------------------------------
FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00%
2/12/13 - 10/31/13 73 7 0 0
11/1/13 - 10/31/14 101 9 0 0
11/1/14 - 10/31/15 21 0 0 0
(1) The Blended Index consists of a 50/50 blend of the BofA Merrill Lynch
Fixed Rate Preferred Securities Index and the BofA Merrill Lynch U.S.
Capital Securities Index. The Blended Index was added to reflect the
diverse allocation of institutional preferred and hybrid securities in the
Fund's portfolio. The indexes do not charge management fees or brokerage
expenses, and no such fees or expenses were deducted from the performance
shown. Indexes are unmanaged and an investor cannot invest directly in an
index.
Page 4
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
ANNUAL REPORT
OCTOBER 31, 2015
SUB-ADVISOR
STONEBRIDGE ADVISORS LLC
Stonebridge Advisors LLC ("Stonebridge" or the "Sub-Advisor") is the Sub-Advisor
to First Trust Preferred Securities and Income ETF (the "Fund") and is a
registered investment advisor based in Wilton, Connecticut. Stonebridge
specializes in the management of preferred securities and North American equity
income securities.
PORTFOLIO MANAGEMENT TEAM
SCOTT T. FLEMING - PRESIDENT AND CIO OF STONEBRIDGE ADVISORS LLC
ROBERT WOLF - VICE PRESIDENT, PORTFOLIO MANAGER AND SENIOR CREDIT ANALYST
DANIELLE SALTERS, CFA - CREDIT ANALYST
COMMENTARY
MARKET RECAP
The fiscal year ended October 31, 2015 was a period of solid returns and strong
relative performance for the preferred and hybrid securities markets. Risk
assets performed well throughout the first half of the period due to the low
rate environment, increasing quantitative easing around the globe, and investor
demand for yield. Outperformance of the preferred and hybrid securities markets,
in particular, was driven by the excess spread and yield available and the
improved creditworthiness of financials. During the second half of the period,
we saw a bifurcation between the retail and institutional markets as the $1,000
par securities market was far more reactionary to macro events, while the $25
par securities market continued to rally driven by low interest rates and strong
inflows into fund products. The retail market earned 7.50% during the fiscal
year while the institutional market earned 1.60% according to The BofA Merrill
Lynch Fixed Rate Preferred Securities Index ("P0P1") and the BofA Merrill Lynch
U.S. Capital Securities Index ("C0CS"), respectively.
Low interest rates on a global basis continued to support the outperformance of
long-duration fixed-rate securities. This also caused substantial outperformance
of the retail preferred space, which has a higher percentage of fixed-for-life
securities. Additional supporters of the outperformance of retail securities
were the positive technical factors of strong flows into retail exchange-traded
funds ("ETFs") of approximately $3.8 billion and the lack of new retail
securities issuance. Many of the European and U.S. companies that issued new
securities focused on $1,000 par securities in U.S. dollars ("USD"). Low rates,
particularly in Europe, have caused increased European investor participation in
USD deals, driven by absolute yield differentials and a strengthening U.S.
dollar.
PERFORMANCE ANALYSIS
For the fiscal year through October 31, 2015, the net asset value ("NAV") and
market price total return for the Fund were 5.75% and 5.96%, respectively. This
compares to a total return of 4.52% for the Fund's blended index, which is a
50/50 blend of P0P1 and C0CS. This outperformance was achieved in spite of
maintaining a conservative stance on interest rates relative to the blended
index. The primary factors that contributed to outperformance of the Fund
relative to the blended index were better overall security selection and an
overweight in $25 par securities.
Security selection within fixed-to-float securities, which are an important part
of the strategy for managing interest rate risk in the Fund, was a significant
contributor to the outperformance relative to the blended index. The overweight
in $25 par securities, which included securities not held in the blended index,
was also a driver of the positive performance. In general, long-duration
securities within the blended index outperformed shorter-duration securities
during the period. As a result, the Fund's strategy to maintain a shorter
duration than the blended index was a moderate drag on relative performance from
an allocation standpoint, but the superior security selection within the shorter
duration buckets more than offset this detractor. The Fund's weightings in
contingent convertible securities ("CoCos") and non-investment grade securities,
none of which are held in the blended index, were also positive contributors to
performance.
MARKET AND FUND OUTLOOK
The preferred and hybrid securities markets continue to benefit from strong
market technicals and improving credit fundamentals. With recent strong economic
data in the U.S., we believe the end of the zero interest rate policy by the
Federal Reserve is nearly inevitable. We expect that short-term rates will rise
modestly in the U.S. while global interest rates remain low, causing the U.S.
Treasury curve to flatten, with the 10-year and 30-year parts of the curve to
remain low by historical standards. In this environment, we continue to see
attractive yields on preferred and hybrid securities relative to other parts of
the fixed-income market. Furthermore, issuer credit fundamentals, particularly
in the financials sector, should continue to support the preferred and hybrid
securities markets into 2016. Yield spreads of preferred and hybrid securities
relative to both U.S. Treasuries and other credit spread products remain wider
than historical averages, which we believe should help drive positive
performance in the asset class.
Page 5
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
ANNUAL REPORT
OCTOBER 31, 2015
We expect preferred and hybrid securities issuance to be active in 2016 from
both the financials and industrials sectors. Similar to what occurred in 2015,
we anticipate new issuance will be met with strong demand, as buyers have mostly
been long-term investors in search of yield and attractive structures, and many
of the new issues offer a component of rate protection. We also expect more new
issuance to be generated by non-U.S. issuers, particularly European banks
issuing CoCos to meet additional Tier 1 ("AT1") regulatory capital requirements.
Lack of supply within the U.S. hybrid securities market will likely continue to
provide additional support for the secondary market.
We will continue to actively manage the Fund to protect against the downside
risks in the market while aiming to outperform in all market environments on a
risk-adjusted basis. With the potential for rate volatility, we believe it is
prudent to maintain durations shorter than the blended index, particularly if we
can do so while paying income comparable to the blended index yield. We also
continue to favor structures with good rate protection and high current yields.
Despite the impending Federal Reserve rate hike, we believe that a slowly
growing U.S. economy, stable to improving corporate credit, and limited supply
continue to be supportive of the preferred and hybrid securities markets.
Page 6
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
UNDERSTANDING YOUR FUND EXPENSES
OCTOBER 31, 2015 (UNAUDITED)
As a shareholder of First Trust Preferred Securities and Income ETF (the "Fund")
you incur two types of costs: (1) transaction costs; and (2) ongoing costs,
including management fees, distribution and/or service fees, if any, and other
Fund expenses. This Example is intended to help you understand your ongoing
costs of investing in the Fund and to compare these costs with the ongoing costs
of investing in other funds.
The Example is based on an investment of $1,000 invested at the beginning of the
period and held through the six-month period ended October 31, 2015.
ACTUAL EXPENSES
The first line in the following table provides information about actual account
values and actual expenses. You may use the information in this line, together
with the amount you invested, to estimate the expenses that you paid over the
period. Simply divide your account value by $1,000 (for example, an $8,600
account value divided by $1,000 = 8.6), then multiply the result by the number
in the first line under the heading entitled "Expenses Paid During the Six-Month
Period" to estimate the expenses you paid on your account during this six-month
period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line in the following table provides information about hypothetical
account values and hypothetical expenses based on the Fund's actual expense
ratio and an assumed rate of return of 5% per year before expenses, which is not
the Fund's actual return. The hypothetical account values and expenses may not
be used to estimate the actual ending account balance or expenses you paid for
the period. You may use this information to compare the ongoing costs of
investing in the Fund and other funds. To do so, compare this 5% hypothetical
example with the 5% hypothetical examples that appear in the shareholder reports
of the other funds.
Please note that the expenses shown in the table are meant to highlight your
ongoing costs only and do not reflect any transactional costs such as brokerage
commissions. Therefore, the second line in the table is useful in comparing
ongoing costs only, and will not help you determine the relative total costs of
owning different funds. In addition, if these transactional costs were included,
your costs would have been higher.
-------------------------------------------------------------------------------------------------------------------------
ANNUALIZED
EXPENSE RATIO EXPENSES PAID
BEGINNING ENDING BASED ON THE DURING THE
ACCOUNT VALUE ACCOUNT VALUE SIX-MONTH SIX-MONTH
MAY 1, 2015 OCTOBER 31, 2015 PERIOD PERIOD (a)
-------------------------------------------------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF
Actual $1,000.00 $1,018.20 0.85% $4.32
Hypothetical (5% return before expenses) $1,000.00 $1,020.92 0.85% $4.33
(a) Expenses are equal to the annualized expense ratio as indicated in the
table multiplied by the average account value over the period (May 1, 2015
through October 31, 2015), multiplied by 184/365.
Page 7
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 2015
STATED STATED
SHARES DESCRIPTION RATE MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
$25 PAR PREFERRED SECURITIES - 54.9%
BANKS - 18.2%
360,614 Citigroup Capital XIII........................................... 6.69% 10/30/40 $ 9,159,596
37,141 Citigroup, Inc., Series AA....................................... 8.13% (a) 1,058,147
211,427 Citigroup, Inc., Series K (b).................................... 6.88% (a) 5,822,700
150,704 Fifth Third Bancorp, Series I (b)................................ 6.63% (a) 4,204,642
381,992 First Niagara Financial Group., Inc., Series B (b)............... 8.63% (a) 10,520,060
179,263 FNB Corp. (b).................................................... 7.25% (a) 5,234,480
405,931 GMAC Capital Trust I, Series 2 (b)............................... 8.13% 02/15/40 10,485,198
48,764 HSBC USA, Inc., Series F (c)..................................... 3.50% (a) 1,068,907
40,250 JPMorgan Chase & Co., Series W................................... 6.30% (a) 1,048,512
212,837 PNC Financial Services Group, Inc., Series P (b)................. 6.13% (a) 5,927,510
45,783 Royal Bank of Scotland Group PLC, Series R....................... 6.13% (a) 1,144,117
238,662 Royal Bank of Scotland Group PLC, Series S....................... 6.60% (a) 6,059,628
29,229 Santander Finance Preferred SAU., Series 6 (c)................... 4.00% (a) 678,113
128,660 Synovus Financial Corp., Series C (b)............................ 7.88% (a) 3,598,620
35,380 US Bancorp, Series F (b)......................................... 6.50% (a) 1,025,312
42,301 Valley National Bancorp, Series A (b)............................ 6.25% (a) 1,109,555
155,860 Wintrust Financial Corp., Series D (b)........................... 6.50% (a) 4,022,747
61,170 Zions Bancorporation, Series F................................... 7.90% (a) 1,624,063
60,931 Zions Bancorporation, Series G (b)............................... 6.30% (a) 1,592,127
------------
75,384,034
------------
CAPITAL MARKETS - 10.4%
171,730 Apollo Investment Corp........................................... 6.63% 10/15/42 4,343,052
164,186 Apollo Investment Corp........................................... 6.88% 07/15/43 4,171,966
86,939 BGC Partners, Inc................................................ 8.13% 06/15/42 2,362,133
74,793 Deutsche Bank Contingent Capital Trust III....................... 7.60% (a) 1,999,965
114,168 Deutsche Bank Contingent Capital Trust V......................... 8.05% (a) 3,121,353
345,495 Goldman Sachs Group, Inc., Series K (b).......................... 6.38% (a) 9,269,631
206,147 Morgan Stanley, Series E (b)..................................... 7.13% (a) 5,741,194
347,162 Morgan Stanley, Series F (b)..................................... 6.88% (a) 9,390,732
37,848 Raymond James Financial, Inc..................................... 6.90% 03/15/42 1,019,247
18,028 Solar Capital Ltd................................................ 6.75% 11/15/42 440,965
41,509 State Street Corp., Series D (b)................................. 5.90% (a) 1,104,969
------------
42,965,207
------------
CONSUMER FINANCE - 1.6%
234,964 Ally Financial, Inc., Series A (b)............................... 8.50% (a) 6,038,575
17,330 Capital One Financial Corp., Series D............................ 6.70% (a) 471,549
------------
6,510,124
------------
DIVERSIFIED FINANCIAL SERVICES - 2.6%
146,576 KKR Financial Holdings LLC....................................... 8.38% 11/15/41 4,008,854
158,048 KKR Financial Holdings LLC, Series A............................. 7.38% (a) 4,183,530
84,495 RBS Capital Funding Trust VI, Series F........................... 6.25% (a) 2,131,809
13,042 RBS Capital Funding Trust VII, Series G.......................... 6.08% (a) 324,746
------------
10,648,939
------------
DIVERSIFIED TELECOMMUNICATION SERVICES - 1.4%
72,715 Qwest Corp....................................................... 7.38% 06/01/51 1,876,774
149,652 Qwest Corp....................................................... 6.88% 10/01/54 3,861,022
------------
5,737,796
------------
ELECTRIC UTILITIES - 0.4%
61,820 Southern (The) Co................................................ 6.25% 10/15/75 1,629,575
------------
Page 8 See Notes to Financial Statements
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
STATED STATED
SHARES DESCRIPTION RATE MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
$25 PAR PREFERRED SECURITIES (CONTINUED)
FOOD PRODUCTS - 3.9%
382,362 CHS, Inc., Series 2 (b).......................................... 7.10% (a) $ 10,583,780
174,920 CHS, Inc., Series 3 (b).......................................... 6.75% (a) 4,715,843
39,783 CHS, Inc., Series 4.............................................. 7.50% (a) 1,104,774
------------
16,404,397
------------
INSURANCE - 10.5%
199,821 Aegon N.V........................................................ 8.00% 02/15/42 5,531,045
56,500 AmTrust Financial Services, Inc.................................. 7.50% 09/15/55 1,456,005
190,561 Aspen Insurance Holdings Ltd. (b)................................ 5.95% (a) 4,857,400
24,318 Aspen Insurance Holdings Ltd..................................... 7.25% (a) 648,318
299,355 Aspen Insurance Holdings Ltd. (b)................................ 7.40% (a) 7,645,527
288,334 Aviva PLC........................................................ 8.25% 12/01/41 7,787,901
322,774 Endurance Specialty Holdings Ltd., Series A...................... 7.75% (a) 8,321,114
73,939 Global Indemnity PLC............................................. 7.75% 08/15/45 1,774,536
67,795 Hartford Financial Services Group, Inc. (b)...................... 7.88% 04/15/42 2,088,086
226 Maiden Holdings North America Ltd................................ 8.00% 03/27/42 5,876
114,131 PartnerRe Ltd., Series E......................................... 7.25% (a) 3,261,864
------------
43,377,672
------------
MULTI-UTILITIES - 0.5%
85,187 Integrys Energy Group, Inc. (b).................................. 6.00% 08/01/73 2,174,935
------------
OIL, GAS & CONSUMABLE FUELS - 0.6%
93,652 NuStar Logistics, L.P. (b)....................................... 7.63% 01/15/43 2,399,364
------------
REAL ESTATE INVESTMENT TRUSTS - 4.6%
141,306 DuPont Fabros Technology, Inc., Series A......................... 7.88% (a) 3,559,498
38,874 DuPont Fabros Technology, Inc., Series B......................... 7.63% (a) 991,287
45,320 EPR Properties, Series F......................................... 6.63% (a) 1,150,222
47,955 Equity Commonwealth, Series E.................................... 7.25% (a) 1,227,169
23,827 Hospitality Properties Trust, Series D........................... 7.13% (a) 627,841
64,350 Kite Realty Group Trust, Series A............................... 8.25% (a) 1,640,925
69,258 MFA Financial, Inc............................................... 8.00% 04/15/42 1,769,542
35,293 National Retail Properties, Inc., Series D....................... 6.63% (a) 933,853
283,403 VEREIT, Inc., Series F........................................... 6.70% (a) 7,031,228
------------
18,931,565
------------
WIRELESS TELECOMMUNICATION SERVICES - 0.2%
12,149 Telephone & Data Systems, Inc.................................... 6.63% 03/31/45 308,341
26,178 Telephone & Data Systems, Inc.................................... 6.88% 11/15/59 669,110
------------
977,451
------------
TOTAL $25 PAR PREFERRED SECURITIES.......................................................... 227,141,059
(Cost $226,053,458) ------------
$50 PAR PREFERRED SECURITIES - 0.4%
CONSUMER FINANCE - 0.4%
38,952 SLM Corp., Series A.............................................. 6.97% (a) 1,698,307
(Cost $1,872,800) ------------
$100 PAR PREFERRED SECURITIES - 0.5%
BANKS - 0.4%
1,200 AgriBank FCB (b) (d)............................................. 6.88% (a) 125,625
8,500 CoBank ACB, Series F (b) (e)..................................... 6.25% (a) 883,469
5,640 CoBank ACB, Series G............................................. 6.13% (a) 514,474
------------
1,523,568
------------
See Notes to Financial Statements Page 9
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
STATED STATED
SHARES DESCRIPTION RATE MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
$100 PAR PREFERRED SECURITIES (CONTINUED)
CONSUMER FINANCE - 0.1%
12,175 SLM Corp., Series B.............................................. 2.04% (a) $ 572,225
------------
TOTAL $100 PAR PREFERRED SECURITIES......................................................... 2,095,793
(Cost $2,275,453) ------------
$1,000 PAR PREFERRED SECURITIES - 2.3%
BANKS - 1.7%
2,500 AgStar Financial Services ACA (b) (f)............................ 6.75% (a) 2,657,656
3,300 Farm Credit Bank of Texas, Series 1 (f).......................... 10.00% (a) 4,166,250
------------
6,823,906
------------
INSURANCE - 0.2%
1,000 XLIT Ltd., Series D (c).......................................... 3.44% (a) 827,500
------------
REAL ESTATE INVESTMENT TRUSTS - 0.4%
1,456 Sovereign Real Estate Investment Trust (f)....................... 12.00% (a) 1,854,580
------------
TOTAL $1,000 PAR PREFERRED SECURITIES....................................................... 9,505,986
(Cost $9,553,260) ------------
PAR STATED STATED
AMOUNT DESCRIPTION RATE MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
CAPITAL PREFERRED SECURITIES - 39.2%
BANKS - 18.1%
$ 3,000,000 Banco Bilbao Vizcaya Argentaria S.A. (b)......................... 9.00% (a) 3,241,950
1,000,000 Banco do Brasil S.A. (b) (e)..................................... 9.00% (a) 695,000
500,000 Banco do Brasil S.A. (b)......................................... 9.25% (a) 356,875
5,000,000 Bank of America Corp., Series Z (b).............................. 6.50% (a) 5,231,300
4,092,566 Barclays PLC (b)................................................. 6.63% (a) 4,049,062
500,000 Barclays PLC (b)................................................. 8.25% (a) 533,602
1,024,990 BBVA Global Finance Ltd.......................................... 7.00% 12/01/25 1,119,722
3,500,000 BNP Paribas S.A. (b) (e)......................................... 7.38% 12/31/49 3,626,875
1,007,000 BPCE S.A. (b).................................................... 12.50% (a) 1,309,100
2,616,000 Citizens Financial Group, Inc. (b) (e)........................... 5.50% (a) 2,576,760
1,500,000 Cooperatieve Centrale Raiffeisen-Boerenleenbank BA/
Netherlan (b)................................................. 11.00% (a) 1,871,250
900,000 Credit Agricole S.A. (b)......................................... 8.13% 09/19/33 997,145
1,500,000 Credit Agricole S.A. (b)......................................... 8.38% (a) 1,706,400
1,500,000 Credit Agricole S.A. (b) (e)..................................... 8.38% (a) 1,706,400
2,000,000 Dresdner Funding Trust I......................................... 8.15% 06/30/31 2,476,752
5,000,000 Fuerstenberg Capital International Sarl & Cie SECS (b)........... 10.25% (a) 5,186,035
5,000,000 JPMorgan Chase & Co., Series S (b)............................... 6.75% (a) 5,431,250
2,000,000 LBG Capital No.1 PLC (b)......................................... 8.50% (a) 2,336,940
200,000 LBG Capital No.1 PLC (b) (e)..................................... 8.50% (a) 233,901
3,000,000 Lloyds Bank PLC (b).............................................. 12.00% (a) 4,335,000
1,000,000 Natixis S.A. (b)................................................. 10.00% (a) 1,152,500
3,785,000 NIBC Bank N.V.................................................... 7.63% (a) 3,823,403
4,000,000 Royal Bank of Scotland Group PLC (b)............................. 8.00% (a) 4,190,000
2,000,000 Royal Bank of Scotland Group PLC (b)............................. 7.50% 12/31/49 2,075,000
1,000,000 Royal Bank of Scotland Group PLC (b)............................. 7.65% (a) 1,250,000
6,000,000 Societe Generale S.A. (b) (e).................................... 8.00% (a) 6,072,198
1,000,000 Societe Generale S.A. (b)........................................ 7.88% (a) 1,005,630
2,000,000 Societe Generale S.A. (b) (e).................................... 7.88% (a) 2,011,260
500,000 Wells Fargo & Co., Series U (b).................................. 5.88% (a) 529,475
3,500,000 Zions Bancorporation, Series J (b)............................... 7.20% (a) 3,780,000
------------
74,910,785
------------
Page 10 See Notes to Financial Statements
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
PAR STATED STATED
AMOUNT DESCRIPTION RATE MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
CAPITAL PREFERRED SECURITIES (CONTINUED)
CAPITAL MARKETS - 0.9%
$ 400,000 Charles Schwab Corp. (b)......................................... 7.00% (a) $ 465,000
3,000,000 UBS Group AG (b)................................................. 7.13% (a) 3,135,060
------------
3,600,060
------------
DIVERSIFIED FINANCIAL SERVICES - 1.9%
1,000,000 General Electric Capital Corp., Series A (b)..................... 7.13% (a) 1,176,250
2,000,000 General Electric Capital Corp., Series B (b)..................... 6.25% (a) 2,229,200
4,000,000 Glen Meadow Pass Through Trust (b) (e)........................... 6.51% 02/12/67 3,470,000
1,000,000 Macquarie PMI LLC................................................ 8.38% (a) 1,004,825
------------
7,880,275
------------
DIVERSIFIED TELECOMMUNICATION SERVICES - 1.0%
2,000,000 Koninklijke KPN N.V. (b)......................................... 7.00% 03/28/73 2,070,740
2,000,000 Koninklijke KPN N.V. (b) (e)..................................... 7.00% 03/28/73 2,070,740
------------
4,141,480
------------
ELECTRIC UTILITIES - 3.1%
5,325,000 Enel SpA (b) (e)................................................. 8.75% 09/24/73 6,150,375
2,000,000 NextEra Energy Capital Holdings, Inc., Series D (b).............. 7.30% 09/01/67 1,995,000
5,500,000 PPL Capital Funding, Inc., Series A (b).......................... 6.70% 03/30/67 4,648,941
------------
12,794,316
------------
FOOD PRODUCTS - 0.8%
3,000,000 Land O'Lakes Capital Trust I (e)................................. 7.45% 03/15/28 3,195,000
------------
INDEPENDENT POWER AND RENEWABLE ELECTRICITY PRODUCERS - 0.7%
1,500,000 AES Gener S.A. (b) (e)........................................... 8.38% 12/18/73 1,560,000
1,250,000 AES Gener S.A. (b)............................................... 8.38% 12/18/73 1,300,000
------------
2,860,000
------------
INSURANCE - 10.7%
1,200,000 AG Insurance S.A. N.V. (b)....................................... 6.75% (a) 1,297,650
5,150,000 Aquarius + Investments PLC for Swiss Reinsurance Co., Ltd. (b)... 8.25% (a) 5,622,739
6,000,000 Assured Guaranty Municipal Holdings, Inc. (b) (e)................ 6.40% 12/15/66 4,380,000
1,000,000 Aviva PLC........................................................ 8.25% (a) 1,095,580
500,000 Catlin Insurance Co., Ltd. (b)................................... 7.25% (a) 430,000
3,000,000 Catlin Insurance Co., Ltd. (b) (e)............................... 7.25% 12/31/49 2,580,000
500,000 Cloverie PLC for Zurich Insurance Co., Ltd. (b).................. 8.25% (a) 562,385
2,000,000 CNP Assurances (b)............................................... 6.88% 12/31/49 2,151,380
500,000 CNP Assurances (b)............................................... 7.50% (a) 548,842
3,000,000 Friends Life Holdings PLC (b).................................... 7.88% (a) 3,356,418
4,823,000 La Mondiale SAM (b).............................................. 7.63% (a) 5,245,012
5,260,000 Liberty Mutual Group, Inc. (b) (e)............................... 7.00% 03/15/37 5,056,175
325,000 Liberty Mutual Group, Inc. (b) (e)............................... 10.75% 06/15/58 488,313
2,000,000 Meiji Yasuda Life Insurance Co. (b) (e).......................... 5.20% 10/20/45 2,067,912
1,000,000 MetLife Capital Trust X (b) (e).................................. 9.25% 04/08/38 1,392,700
400,000 Mitsui Sumitomo Insurance Co., Ltd. (b) (e)...................... 7.00% 03/15/72 465,500
1,100,000 Nationwide Financial Services, Inc............................... 6.75% 05/15/37 1,133,000
6,600,000 Sirius International Group Ltd. (b) (f).......................... 7.51% (a) 6,682,500
------------
44,556,106
------------
METALS & MINING - 2.0%
3,000,000 BHP Billiton Finance USA Ltd. (b) (e)............................ 6.25% 10/19/75 3,071,250
5,000,000 BHP Billiton Finance USA Ltd. (b) (e)............................ 6.75% 10/19/75 5,106,250
------------
8,177,500
------------
TOTAL CAPITAL PREFERRED SECURITIES.......................................................... 162,115,522
(Cost $163,807,308) ------------
See Notes to Financial Statements Page 11
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
STATED STATED
SHARES DESCRIPTION RATE MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
CORPORATE BONDS AND NOTES - 1.2%
INSURANCE - 1.2%
$ 5,000,000 Land O' Lakes, Inc. (f).......................................... 8.00% (a) $ 5,168,750
(Cost $5,000,000) ------------
SHARES DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
CLOSED-END FUNDS - 0.3%
CAPITAL MARKETS - 0.3%
47,740 Flaherty & Crumrine Dynamic Preferred and Income Fund, Inc.................................. 1,095,156
(Cost $1,084,765) ------------
TOTAL INVESTMENTS - 98.8%................................................................... 408,820,573
(Cost $409,647,044) (g)
NET OTHER ASSETS AND LIABILITIES - 1.2%..................................................... 4,884,723
------------
NET ASSETS - 100.0%......................................................................... $413,705,296
============
(a) Perpetual maturity.
(b) Fixed-to-floating or fixed-to-variable rate security. The interest rate
shown reflects the fixed rate in effect at October 31, 2015. At a
predetermined date, the fixed rate will change to a floating rate or a
variable rate.
(c) Floating rate security. The interest rate shown reflects the rate in
effect at October 31, 2015.
(d) Pursuant to procedures adopted by the Trust's Board of Trustees, this
security has been determined to be illiquid by Stonebridge Advisors LLC,
the Fund's sub-advisor (the "Sub-Advisor").
(e) 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 Trust's Board of Trustees,
this security has been determined to be liquid by the 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 October 31, 2015, securities noted as such amounted to
$58,860,078 or 14.23% of net assets.
(f) 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).
(g) Aggregate cost for federal income tax purposes is $409,654,700. As of
October 31, 2015, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was
$4,638,476 and the aggregate gross unrealized depreciation for all
securities in which there was an excess of tax cost over value was
$5,472,603.
Page 12 See Notes to Financial Statements
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
-----------------------------
VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of October 31,
2015 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
INVESTMENTS 10/31/2015 PRICES INPUTS INPUTS
--------------------------------------------------- ------------- ------------- -------------- --------------
$25 Par Preferred Securities:
Multi-Utilities................................. $ 2,174,935 $ -- $ 2,174,935 $ --
Other Industry Categories*...................... 224,966,124 224,966,124 -- --
$50 Par Preferred Securities*...................... 1,698,307 1,698,307 -- --
$100 Par Preferred Securities:
Consumer Finance................................ 572,225 572,225 -- --
Other Industry Categories*...................... 1,523,568 -- 1,523,568 --
$1,000 Par Preferred Securities*................... 9,505,986 -- 9,505,986 --
Capital Preferred Securities*...................... 162,115,522 -- 162,115,522 --
Corporate Bonds and Notes*......................... 5,168,750 -- 5,168,750 --
Closed-End Funds*.................................. 1,095,156 1,095,156 -- --
------------- ------------- -------------- --------------
Total Investments.................................. $ 408,820,573 $ 228,331,812 $ 180,488,761 $ --
============= ============= ============== ==============
* See the 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 their current value. As of October 31,
2015, the Fund transferred $25 par preferred securities valued at $954,105 from
Level 1 to Level 2 due to use of observable market inputs not in an active
market.
See Notes to Financial Statements Page 13
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 2015
ASSETS:
Investments, at value................................................. $ 408,820,573
Cash.................................................................. 2,456,541
Receivables:
Capital shares sold................................................ 3,795,169
Interest........................................................... 2,439,705
Dividends.......................................................... 849,343
Investment securities sold......................................... 496,273
Tax reclaims....................................................... 52,369
Other assets.......................................................... 48,456
-----------------
Total Assets....................................................... 418,958,429
-----------------
LIABILITIES:
Payables:
Investment securities purchased.................................... 4,968,544
Investment advisory fees........................................... 284,589
-----------------
Total Liabilities.................................................. 5,253,133
-----------------
NET ASSETS............................................................ $ 413,705,296
=================
NET ASSETS CONSIST OF:
Paid-in capital....................................................... $ 419,752,557
Par value............................................................. 218,050
Accumulated net investment income (loss).............................. 521,422
Accumulated net realized gain (loss) on investments................... (5,960,262)
Net unrealized appreciation (depreciation) on investments............. (826,471)
-----------------
NET ASSETS............................................................ $ 413,705,296
=================
NET ASSET VALUE, per share............................................ $ 18.97
=================
Number of shares outstanding (unlimited number of
shares authorized, par value $0.01 per share)...................... 21,805,000
=================
Investments, at cost.................................................. $ 409,647,044
=================
Page 14 See Notes to Financial Statements
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED OCTOBER 31, 2015
INVESTMENT INCOME:
Dividends............................................................. $ 8,768,477
Interest.............................................................. 6,380,375
Foreign tax withholding............................................... (468)
Other................................................................. 8
-----------------
Total investment income............................................ 15,148,392
-----------------
EXPENSES:
Investment advisory fees.............................................. 1,840,347
-----------------
Total expenses..................................................... 1,840,347
-----------------
NET INVESTMENT INCOME (LOSS).......................................... 13,308,045
-----------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on:
Investments........................................................ (353,677)
In-kind redemptions................................................ 97,683
-----------------
Net realized gain (loss).............................................. (255,994)
-----------------
Net change in unrealized appreciation (depreciation) on investments... (1,274,548)
-----------------
NET REALIZED AND UNREALIZED GAIN (LOSS)............................... (1,530,542)
-----------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING
FROM OPERATIONS.................................................... $ 11,777,503
=================
See Notes to Financial Statements Page 15
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEAR ENDED OCTOBER 31, 2015
FOR THE YEAR FOR THE YEAR
ENDED ENDED
10/31/2015 10/31/2014
---------------- ----------------
OPERATIONS:
Net investment income (loss).......................................... $ 13,308,045 $ 3,895,121
Net realized gain (loss).............................................. (255,994) (2,534,995)
Net change in unrealized appreciation (depreciation).................. (1,274,548) 4,543,169
---------------- ----------------
Net increase (decrease) in net assets resulting from operations ...... 11,777,503 5,903,295
---------------- ----------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income................................................. (13,052,254) (3,548,355)
---------------- ----------------
Total distributions to shareholders................................... (13,052,254) (3,548,355)
---------------- ----------------
SHAREHOLDER TRANSACTIONS:
Proceeds from shares sold............................................. 333,925,194 33,332,529
Cost of shares redeemed............................................... (5,663,344) (13,691,744)
---------------- ----------------
Net increase (decrease) in net assets resulting from
shareholder transactions........................................... 328,261,850 19,640,785
---------------- ----------------
Total increase (decrease) in net assets............................... 326,987,099 21,995,725
NET ASSETS:
Beginning of year..................................................... 86,718,197 64,722,472
---------------- ----------------
End of year........................................................... $ 413,705,296 $ 86,718,197
================ ================
Accumulated net investment income (loss) at end of year............... $ 521,422 $ 189,746
================ ================
CHANGES IN SHARES OUTSTANDING:
Shares outstanding, beginning of period............................... 4,555,000 3,555,000
Shares sold........................................................... 17,550,000 1,750,000
Shares redeemed....................................................... (300,000) (750,000)
---------------- ----------------
Shares outstanding, end of period..................................... 21,805,000 4,555,000
================ ================
Page 16 See Notes to Financial Statements
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FOR THE PERIOD
2/11/2013 (a)
YEAR ENDED YEAR ENDED THROUGH
10/31/2015 10/31/2014 10/31/2013
-------------- -------------- --------------
Net asset value, beginning of period $ 19.04 $ 18.21 $ 19.99
---------- ---------- ----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) 1.16 (b) 1.10 0.65
Net realized and unrealized gain (loss) (0.10) 0.76 (1.78)
---------- ---------- ----------
Total from investment operations 1.06 1.86 (1.13)
---------- ---------- ----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (1.13) (1.03) (0.62)
Return of capital -- -- (0.03)
---------- ---------- ----------
Total distributions (1.13) (1.03) (0.65)
---------- ---------- ----------
Net asset value, end of period $ 18.97 $ 19.04 $ 18.21
========== ========== ==========
TOTAL RETURN (c) 5.75% 10.42% (5.74)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 413,705 $ 86,718 $ 64,722
RATIOS TO AVERAGE NET ASSETS:
Ratio of total expenses to average net assets 0.85% 0.85% 0.85% (d)
Ratio of net investment income (loss) to
average net assets 6.15% 6.06% 5.44% (d)
Portfolio turnover rate (e) 50% 91% 45%
(a) Inception date is consistent with the commencement of investment
operations and is the date the initial creation units were established.
First Trust Portfolios L.P. seeded the First Trust Preferred Securities
and Income ETF on January 29, 2013 in order to provide initial capital
required by SEC rules.
(b) Based on average shares outstanding.
(c) Total return is calculated assuming an initial investment made at the net
asset value at the beginning of the period, reinvestment of all
distributions at net asset value during the period, and redemption at net
asset value on the last day of the period. The returns presented do not
reflect the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption or sale of Fund shares. Total return is
calculated for the time period presented and is not annualized for periods
of less than a year.
(d) Annualized.
(e) Portfolio turnover is calculated for the time period presented and is not
annualized for periods of less than a year and does not include securities
received or delivered from processing creations or redemptions and in-kind
transactions.
See Notes to Financial Statements Page 17
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015
1. ORGANIZATION
First Trust Exchange-Traded Fund III (the "Trust") is a non-diversified open-end
management investment company organized as a Massachusetts business trust on
January 9, 2008, and is registered with the Securities and Exchange Commission
under the Investment Company Act of 1940, as amended (the "1940 Act").
The Trust currently consists of four funds that are offering shares. This report
covers the First Trust Preferred Securities and Income ETF (the "Fund"), which
trades under the ticker FPE on the NYSE Arca, Inc. Unlike conventional mutual
funds, the Fund issues and redeems shares on a continuous basis, at net asset
value ("NAV"), only in large specified blocks consisting of 50,000 shares called
a "Creation Unit." Creation Units are issued and redeemed for securities in
which the Fund invests or for cash or, in certain circumstances, a combination
of both. Except when aggregated in Creation Units, the shares are not redeemable
securities of the Fund.
The Fund is an actively managed exchange-traded fund. The investment objective
of the Fund is to seek total return and to provide current income. Under normal
market conditions, the Fund invests at least 80% of its net assets (including
investment borrowings) in preferred securities and income-producing debt
securities including corporate bonds, high-yield securities and convertible
securities. There can be no assurance that the Fund will achieve its investment
objective. The Fund may not be appropriate for all investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The Fund, which is an investment company within the scope of Financial
Accounting Standards Board ("FASB") Accounting Standards Update 2013-08, follows
accounting and reporting guidance under FASB Accounting Standards Codification
Topic 946, "Financial Services-Investment Companies." The following is a summary
of significant accounting policies consistently followed by the Fund in the
preparation of the 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 Fund's NAV is determined daily as of the close of regular trading on the New
York Stock Exchange ("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 Fund's NAV is calculated by dividing the value of all
assets of the Fund (including accrued interest and dividends), less all
liabilities (including accrued expenses and dividends declared but unpaid), by
the total number of shares outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value. Market
value prices represent last sale or official closing prices from a national or
foreign exchange (i.e., a regulated market) and are primarily obtained from
third-party pricing services. Fair value prices represent any prices not
considered market value prices and are either obtained from a third-party
pricing service or are determined by the Pricing Committee of the Fund's
investment advisor, First Trust Advisors L.P. ("First Trust" or the "Advisor"),
in accordance with valuation procedures adopted by the Trust's Board of
Trustees, and in accordance with provisions of the 1940 Act. Investments valued
by the Advisor's Pricing Committee, if any, are footnoted as such in the
footnotes to the Portfolio of Investments. The Fund's investments are valued as
follows:
Preferred 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.
Bonds, notes 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 Trust'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.
Page 18
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015
Securities traded in an over-the-counter market are fair valued at the
mean of their most recent bid and asked price, if available, and otherwise
at their closing bid price.
Fixed income and other debt securities having a remaining maturity of 60
days or less when purchased are fair valued at cost adjusted for
amortization of premiums and accretion of discounts (amortized cost),
provided the Advisor's Pricing Committee has determined that the use of
amortized cost is an appropriate reflection of fair value given market and
issuer-specific conditions existing at the time of the determination.
Factors that may be considered in determining the appropriateness of the
use of amortized cost include, but are not limited to, the following:
1) the credit conditions in the relevant market and changes thereto;
2) the liquidity conditions in the relevant market and changes thereto;
3) the interest rate conditions in the relevant market and changes
thereto (such as significant changes in interest rates);
4) issuer-specific conditions (such as significant credit
deterioration); and
5) any other market-based data the Advisor's Pricing Committee
considers relevant. In this regard, the Advisor's Pricing Committee
may use last-obtained market-based data to assist it when valuing
portfolio securities using amortized cost.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Trust's Board of Trustees or its
delegate, the Advisor's Pricing Committee, at fair value. These securities
generally include, but are not limited to, restricted securities (securities
which may not be publicly sold without registration under the Securities Act of
1933, as amended (the "1933 Act")) for which a pricing service is unable to
provide a market price; securities whose trading has been formally suspended; a
security whose market or fair value price is not available from a
pre-established pricing source; a security with respect to which an event has
occurred that is likely to materially affect the value of the security after the
market has closed but before the calculation of the Fund's NAV or make it
difficult or impossible to obtain a reliable market quotation; and a security
whose price, as provided by the pricing service, does not reflect the security's
fair value. As a general principle, the current fair value of a security would
appear to be the amount which the owner might reasonably expect to receive for
the security upon its current sale. When fair value prices are used, generally
they will differ from market quotations or official closing prices on the
applicable exchanges. A variety of factors may be considered in determining the
fair value of such securities, including, but not limited to, the following:
1) the type of security;
2) the size of the holding;
3) the initial cost of the security;
4) transactions in comparable securities;
5) price quotes from dealers and/or pricing services;
6) relationships among various securities;
7) information obtained by contacting the issuer, analysts, or the
appropriate stock exchange;
8) an analysis of the issuer's financial statements; and
9) the existence of merger proposals or tender offers that might affect
the value of the security.
If the securities in question are foreign securities, the following additional
information may be considered:
1) the value of similar foreign securities traded on other foreign
markets;
2) ADR trading of similar securities;
3) closed-end fund trading of similar securities;
4) foreign currency exchange activity;
5) the trading prices of financial products that are tied to baskets of
foreign securities;
6) factors relating to the event that precipitated the pricing problem;
7) whether the event is likely to recur; and
8) whether the effects of the event are isolated or whether they affect
entire markets, countries or regions.
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.
Page 19
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015
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 methodologies 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 October 31, 2015, is
included with the Fund's Portfolio of Investments.
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.
Dividend income is recorded on the ex-dividend date. Interest income, if any, is
recorded on the accrual basis. Amortization of premiums and accretion of
discounts are recorded using the effective interest method.
Distributions received from the Fund's investments in real estate investment
trusts ("REITs") may be comprised of return of capital, capital gains and
income. The actual character of the amounts received during the year are not
known until after the REIT's fiscal year end. The Fund records the character of
distributions received from the REITs during the year based on estimates
available. The characterization of distributions received by the Fund may be
subsequently revised based on information received from the REITs after their
tax reporting periods conclude.
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 October 31, 2015, the Fund held restricted
securities as shown in the following table that Stonebridge Advisors LLC
("Stonebridge" or the "Sub-Advisor") has deemed illiquid pursuant to procedures
adopted by the Trust'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.
SHARES/ % OF
ACQUISITION PAR CARRYING NET
SECURITY DATE AMOUNT PRICE COST VALUE ASSETS
-----------------------------------------------------------------------------------------------------------------------------
AgStar Financial Services
ACA, 6.75% 7/31/15 2,500 $ 1,063.06 $ 2,631,250 $ 2,657,656 0.64%
Farm Credit Bank of Texas,
Series 1, 10.00% 1/30/15 - 9/18/15 3,300 1,262.50 4,148,750 4,166,250 1.01
Land O'Lakes, Inc., 8.00% 7/9/15 $5,000,000 1.03 5,000,000 5,168,750 1.25
Sirius International Group
Ltd., 7.51% 8/6/14 - 9/1/15 $6,600,000 1.01 6,908,250 6,682,500 1.61
Sovereign Real Estate
Investment Trust, 12.00% 5/12/14 - 2/5/15 1,456 1,273.75 1,945,760 1,854,580 0.45
------------- ------------- ---------
$ 20,634,010 $ 20,529,736 4.96%
============= ============= =========
D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income, if any, are declared and paid monthly, or
as the Board of Trustees may determine from time to time. Distributions of net
realized capital gains earned by the Fund, if any, will be distributed at least
annually.
Distributions from income and capital gains are determined in accordance with
federal 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 net asset value
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 time in the future.
Page 20
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015
The tax character of distributions paid during the fiscal year ended October 31,
2015 and the period ended October 31, 2014 was as follows:
Distributions paid from: 2015 2014
Ordinary income................................ $ 13,052,254 $ 3,548,355
Capital gain................................... $ -- $ --
Return of capital.............................. $ -- $ --
As of October 31, 2015, the components of distributable earnings on a tax basis
were as follows:
Undistributed ordinary income.................. $ 362,442
Accumulated capital and other losses........... (5,793,626)
Net unrealized appreciation (depreciation)..... (834,127)
E. 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 and 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.
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. The taxable years ended 2013,
2014 and 2015 remain open to federal and state audit. As of October 31, 2015,
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.
The Fund intends to utilize provisions of the federal income tax laws, which
allow it to carry a realized capital loss forward indefinitely following the
year of the loss and offset such loss against any future realized capital gains.
The Fund is subject to certain limitations under U.S. tax rules on the use of
capital carryforwards and net unrealized built-in losses. These limitations
apply when there has been a 50% change in ownership. At October 31, 2015, the
Fund had non-expiring capital loss carryforwards for federal income tax purposes
of $5,793,626.
Certain losses realized during the current fiscal year may be deferred and
treated as occurring on the first day of the following fiscal year for federal
income tax purposes. For the fiscal year ended October 31, 2015, the Fund had no
net ordinary losses. In order to present paid-in capital, accumulated net
investment income (loss) and accumulated net realized gain (loss) on investments
on the Statement of Assets and Liabilities that more closely represent their tax
character, certain adjustments have been made to paid-in capital, accumulated
net investment income (loss) and accumulated net realized gain (loss) on
investments. These adjustments are primarily due to the difference between book
and tax treatments of income and gains on various investment securities held by
the Fund and in-kind transactions. The results of operations and net assets were
not affected by these adjustments. For the fiscal year ended October 31, 2015,
the adjustments for the Fund were as follows:
Accumulated
Accumulated Net Realized
Net Investment Gain (Loss) Paid-in
Income (Loss) on Investments Capital
--------------- --------------- --------------
$ 75,885 $ (163,379) $ 87,494
F. EXPENSES
Expenses, other than the investment advisory fee and other excluded expenses,
are paid by the Advisor (See Note 3).
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 supervising the selection and ongoing monitoring of the
securities in the Fund's portfolio, managing the Fund's business affairs and
providing certain administrative services necessary for the management of the
Fund.
Page 21
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015
Stonebridge, an affiliate of First Trust, serves as the Fund's sub-advisor and
manages the Fund's portfolio subject to First Trust's supervision. Pursuant to
the Investment Management Agreement between the Trust and the Advisor, First
Trust will supervise Stonebridge and its management of the investment of the
Fund's assets and will pay Stonebridge for its services as the Fund's
sub-advisor. First Trust and Stonebridge are equally responsible for the Fund's
expenses, including the cost of transfer agency, custody, fund administration,
legal, audit and other services, but excluding fee payments under the Investment
Management Agreement, interest, taxes, acquired fund fees and expenses,
brokerage commissions and other expenses connected with the execution of
portfolio transactions, distribution and service fees pursuant to a 12b-1 plan,
if any, and extraordinary expenses. The Fund has agreed to pay First Trust an
annual unitary management fee equal to 0.85% of its average daily net assets.
Stonebridge receives a sub-advisory fee equal to 0.425% of the average daily net
assets of the Fund less Stonebridge's share of the Fund's expenses. The
Sub-Advisor's fee is paid by the Advisor out of the Advisor's management fee.
First Trust also provides fund reporting services to the Fund for a flat annual
fee in the amount of $9,250, which is covered under the annual unitary
management fee.
The Trust has multiple service agreements with Brown Brothers Harriman & Co.
("BBH"). Under the service agreements, BBH performs custodial, fund accounting,
certain administrative services, and transfer agency services for the Fund. As
custodian, BBH is responsible for custody of the Fund's assets. As fund
accountant and administrator, BBH is responsible for maintaining the books and
records of the Fund's securities and cash. As transfer agent, BBH is responsible
for maintaining shareholder records for the Fund.
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 that is allocated pro rata among each fund in the First Trust Fund
Complex based on net assets. Each Independent Trustee is also paid an annual per
fund fee that varies based on whether the fund is a closed-end or other actively
managed fund, or is an index fund.
Additionally, the Lead Independent Trustee and the Chairmen of the Audit
Committee, Nominating and Governance Committee and Valuation Committee are paid
annual fees 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 Committee Chairmen rotate every
three years. The officers and "Interested" Trustee receive no compensation from
the Trust for acting in such capacities.
4. PURCHASES AND SALES OF SECURITIES
For the year ended October 31, 2015, the cost of purchases and proceeds from
sales of investments, excluding short-term investments and in-kind transactions,
for the Fund were $271,061,408 and $107,664,257, respectively.
For the year ended October 31, 2015, the cost of in-kind purchases and proceeds
from in-kind sales for the Fund was $165,081,584 and $2,941,127, respectively.
5. CREATIONS, REDEMPTIONS AND TRANSACTION FEES
Shares are created and redeemed by the Fund only in Creation Unit size
aggregations of 50,000 shares in transactions with broker-dealers or large
institutional investors that have entered into a participation agreement (an
"Authorized Participant"). In order to purchase Creation Units of the Fund, an
Authorized Participant must deposit (i) a designated portfolio of securities and
other instruments determined by First Trust (the "Deposit Securities") and
generally make or receive a cash payment referred to as the "Cash Component,"
which is an amount equal to the difference between the NAV of the Fund shares
(per Creation Unit aggregations) and the market value of the Deposit Securities,
and/or (ii) cash in lieu of all or a portion of the Deposit Securities. If the
Cash Component is a positive number (i.e., the NAV per Creation Unit Aggregation
exceeds the Deposit Amount), the Authorized Participant will deliver the Cash
Component. If the Cash Component is a negative number (i.e., the NAV per
Creation Unit Aggregation is less than the Deposit Amount), the Authorized
Participant will receive the Cash Component. Purchasers of Creation Units must
pay to BBH, as transfer agent, a creation fee (the "Creation Transaction Fee")
regardless of the number of Creation Units purchased in the transaction. The
Creation Transaction Fee may vary and is based on the composition of the
securities included in the Fund's portfolio and the countries in which the
transactions are settled. The Creation Transaction Fee may increase or decrease
as the Fund's portfolio is adjusted to conform to changes in the composition of
the securities included in the Fund's portfolio and the countries in which the
transaction settled. The Creation Transaction Fee is currently $500. The price
for each Creation Unit will equal the daily NAV per share times the number of
shares in a Creation Unit plus the fees described above and, if applicable, any
operational processing and brokerage costs, transfer fees or stamp taxes. When
the Fund permits an Authorized Participant to substitute cash or a different
security in lieu of depositing one or more of the requisite Deposit Securities,
the Authorized Participant may also be assessed an amount to cover the cost of
purchasing the Deposit Securities and/or disposing of the substituted
securities, including operational processing and brokerage costs, transfer fees,
stamp taxes, and part or all of the spread between the expected bid and offer
side of the market related to such Deposit Securities and/or substitute
securities.
Page 22
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015
Authorized Participants redeeming Creation Units must pay to BBH, as transfer
agent, a redemption transaction fee (the "Redemption Transaction Fee"),
regardless of the number of Creation Units redeemed in the transaction. The
Redemption Transaction Fee may vary and is based on the composition of the
securities included in the Fund's portfolio and the countries in which the
transactions are settled. The Redemption Transaction Fee is currently $500. The
Fund reserves the right to effect redemptions in cash. An Authorized Participant
may request cash redemption in lieu of securities; however, the Fund may, in its
discretion, reject any such request.
6. LINE OF CREDIT
Effective April 25, 2014, the Trust, First Trust Series Fund and First Trust
Exchange-Traded Fund IV entered into an $80 million Credit Agreement with the
Bank of Nova Scotia ("Scotia") as administrative agent for a group of lenders.
Prior to March 26, 2015 a commitment fee of 0.125% of the daily amount of the
excess of the commitment amount over the outstanding principal balance of the
loans was charged by Scotia. Effective March 26, 2015, the commitment fee was
changed to 0.15%. First Trust allocates the commitment fee amongst the funds
that have access to the credit line. To the extent that the Fund accesses the
credit line, there would also be an interest fee charged. The Fund did not have
any borrowings outstanding during the year ended October 31, 2015.
7. DISTRIBUTION PLAN
The Board of Trustees adopted a Distribution and Service Plan pursuant to Rule
12b-1 under the 1940 Act. In accordance with the Rule 12b-1 plan, the Fund is
authorized to pay an amount up to 0.25% of its average daily net assets each
year to reimburse First Trust Portfolios L.P. ("FTP"), the distributor of the
Fund, for amounts expended to finance activities primarily intended to result in
the sale of Creation Units or to provide investor services. FTP may also use
this amount to compensate securities dealers or other persons that are
Authorized Participants for providing distribution assistance, including
broker-dealer and shareholder support and educational and promotional services.
No 12b-1 fees are currently paid by the Fund, and pursuant to a contractual
arrangement, no 12b-1 fees will be paid any time before February 28, 2017.
8. INDEMNIFICATION
The Trust, on behalf of the Fund, has a variety of indemnification obligations
under contracts with its service providers. The Trust's maximum exposure under
these arrangements is unknown. However, the Trust has not had prior claims or
losses pursuant to these contracts and expects the risk of loss to be remote.
9. 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 November 19, 2015, the Fund declared a distribution of $0.123 per share to
shareholders of record on November 24, 2015, payable November 30, 2015.
At a meeting on December 7, 2015, the Board accepted Mr. Bradley's resignation
from his position as the President and Chief Executive Officer of the Trust,
effective December 31, 2015. At the same meeting, the Board elected Mr. Dykas to
serve as the President and Chief Executive Officer and Mr. Donald Swade,
formerly an Assistant Treasurer of the Trust, to serve as the Treasurer, Chief
Financial Officer and Chief Accounting Officer of the Trust.
Management anticipates that sometime before the end of December 2015, First
Trust Portfolios L.P., First Trust's affiliate, will transfer its ownership
interest in Stonebridge to First Trust Capital Partners LLC, an affiliate of
both First Trust and First Trust Portfolios L.P. Like First Trust, First Trust
Portfolios L.P. and First Trust Capital Partners LLC are owned by The Charger
Corporation and Grace Partners of DuPage L.P. The anticipated transfer will not
amount to a change of control of Stonebridge or an assignment of the
sub-advisory agreement between the Fund and Stonebridge, and will otherwise have
no effect on the Fund.
Page 23
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------------------------------
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST PREFERRED SECURITIES
AND INCOME ETF:
We have audited the accompanying statement of assets and liabilities of First
Trust Preferred Securities and Income ETF (the "Fund"), a series of the First
Trust Exchange-Traded Fund III, including the portfolio of investments, as of
October 31, 2015, and the related statement of operations for the year then
ended, the statements of changes in net assets for each of the two years in the
period then ended, and the financial highlights for each of the periods
presented. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of October 31, 2015 by correspondence with the Fund's
custodian and brokers; when replies were not received from brokers, we performed
other auditing procedures. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of First
Trust Preferred Securities and Income ETF as of October 31, 2015, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended, and the financial highlights for each
of the periods presented, in conformity with accounting principles generally
accepted in the United States of America.
/s/ Deloitte & Touche LLP
Chicago, Illinois
December 23, 2015
Page 24
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015 (UNAUDITED)
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Trust 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.
PORTFOLIO HOLDINGS
The Trust 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 Trust's Form N-Qs
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.
FEDERAL TAX INFORMATION
For the taxable year ended October 31, 2015, the following percentages of income
dividend paid by the Fund qualify for the dividends received deduction available
to corporations and is hereby designated as qualified dividend income:
Dividends Received Deduction Qualified Dividend Income
---------------------------- ----------------------------
33.81% 60.29%
RISK CONSIDERATIONS
You could lose money by investing in the Fund. An investment in the Fund is not
a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other governmental agency. There can be no
assurance that the Fund's investment objective will be achieved.
CASH TRANSACTIONS RISK. The Fund may under certain circumstances effect a
portion of creations and redemptions for cash, rather than in-kind securities.
As a result, an investment in the Fund may be less tax-efficient than an
investment in an ETF that effects its creations and redemption for in-kind
securities. Because the Fund may effect a portion of redemptions for cash, it
may be required to sell portfolio securities in order to obtain the cash needed
to distribute redemption proceeds. A sale of shares may result in capital gains
or losses, and may also result in higher brokerage costs.
CONCENTRATION RISK. A fund concentrated in a single industry or sector is likely
to present more risks than a fund that is broadly diversified over several
industries or sectors. Compared to the broad market, an individual industry or
sector may be more strongly affected by changes in the economic climate, broad
market shifts, moves in a particular dominant stock, or regulatory changes.
CREDIT RISK. Credit risk is the risk that an issuer of a security will be unable
or unwilling to make dividend, interest and/or principal payments when due and
the related risk that the value of a security may decline because of concerns
about the issuer's ability to make such payments. Credit risk may be heightened
if the Fund invests in "high yield" or "junk" debt; such securities, while
generally offering higher yields than investment grade debt with similar
maturities, involve greater risks, including the possibility of dividend or
interest deferral, default or bankruptcy, and are regarded as predominantly
speculative with respect to the issuer's capacity to pay dividends or interest
and repay principal.
DEPOSITARY RECEIPTS RISK. Depositary receipts may be less liquid than the
underlying securities in their primary trading market. Any distributions paid to
the holders of depositary receipts are usually subject to a fee charged by the
depositary. Holders of depositary receipts may have limited voting rights, and
investment restrictions in certain countries may adversely impact the value of
depositary receipts because such restrictions may limit the ability to convert
the securities into depositary receipts and vice versa. Such restrictions may
cause the securities of the underlying issuer to trade at a discount or premium
to the market price of the depositary receipts.
FINANCIAL COMPANY RISK. Financial companies are especially subject to the
adverse effects of economic recession, currency exchange rates, government
regulation, decreases in the availability of capital, volatile interest rates,
portfolio concentrations in geographic markets and in commercial and residential
real estate loans, and competition from new entrants in their fields of
business.
Page 25
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015 (UNAUDITED)
HIGH YIELD SECURITIES RISK. High yield securities are subject to greater market
fluctuations and risk of loss than securities with higher ratings. These
securities are issued by companies that may have limited operating history,
narrowly focused operations, and/or other impediments to the timely payment of
periodic interest and principal at maturity. If the economy slows down or dips
into recession, the issuers of high yield securities may not have sufficient
resources to continue making timely payment of periodic interest and principal
at maturity. The market for high yield securities is smaller and less liquid
than that for investment grade securities. High yield securities are generally
not listed on a national securities exchange but trade in the over-the-counter
markets. Due to the smaller, less liquid market for high yield securities, the
bid-offer spread on such securities is generally greater than it is for
investment grade securities and the purchase or sale of such securities may take
longer to complete.
ILLIQUID SECURITIES RISK. Illiquid securities involve the risk that the
securities will not be able to be sold at the time desired by the Fund or at
prices approximately the value at which the Fund is carrying the securities on
its books.
INCOME RISK. If interest rates fall, the income from the Fund's portfolio will
decline as the Fund invests the proceeds from new share sales, or from matured
or called debt securities, at interest rates that are below the portfolio's
current earnings rate.
INTEREST RATE RISK. If interest rates rise, the prices of the fixed-rate
instruments held by the Fund may fall.
MANAGEMENT RISK. The Fund is subject to management risk because it is an
actively managed portfolio. In managing the Fund's investment portfolio, the
sub-advisor will apply investment techniques and risk analyses that may not have
the desired result. There can be no guarantee that the Fund will meet its
investment objective.
MARKET RISK. Market risk is the risk that a particular security owned by the
Fund or shares of the Fund in general may fall in value. Securities are subject
to market fluctuations caused by such factors as economic, political, regulatory
or market developments, changes in interest rates and perceived trends in
securities prices. Overall securities values could decline generally or could
underperform other investments.
NEW FUND RISK. The Fund currently has fewer assets than larger funds, and like
other relatively new funds, large inflows and outflows may impact the Fund's
market exposure for limited periods of time. This impact may be positive or
negative, depending on the direction of market movement during the period
effected.
NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the
1940 Act. As a result, the Fund is only limited as to the percentage of its
assets which may be invested in the securities of any one issuer by the
diversification requirements imposed by the Internal Revenue Code of 1986, as
amended. The Fund may invest a relatively high percentage of its assets in a
limited number of issuers. As a result, the Fund may be more susceptible to a
single adverse economic or regulatory occurrence affecting one or more of these
issuers, experience increased volatility and be highly concentrated in certain
issuers.
NON-U.S. SECURITIES RISK. The Fund may invest in securities of non-U.S. issuers.
Such securities are subject to higher volatility than securities of domestic
issuers due to possible adverse political, social or economic developments,
restrictions on foreign investment or exchange of securities, lack of liquidity,
currency exchange rates, excessive taxation, government seizure of assets,
different legal or accounting standards, and less government supervision and
regulation of exchanges in foreign countries.
PREFERRED SECURITIES RISK. Preferred Securities combine some of the
characteristics of both common stocks and bonds. Preferred Securities are
typically subordinated to bonds and other debt instruments in a company's
capital structure, in terms of priority to corporate income, and therefore will
be subject to greater credit risk than those debt instruments. Preferred
Securities are also subject to credit risk, interest rate risk and income risk.
REIT RISK. Investing in REITs involves risks related to their structure and
focus, which include, but are not limited to, dependency upon management skills,
limited diversification, the risks of locating and managing financing for
projects, heavy cash flow dependency, possible default by borrowers, the costs
and potential losses of self-liquidation of one or more holdings, the risk of a
possible lack of mortgage funds and associated interest rate risks,
overbuilding, property vacancies, increases in property taxes and operating
expenses, changes in zoning laws, losses due to environmental damages, changes
in neighborhood values and appeal to purchases, the possibility of failing to
maintain exemptions from registration under the 1940 Act and, in many cases,
relatively small market capitalization, which may result in less market
liquidity and greater price volatility. Fund shareholders indirectly pay REIT
fees and expenses.
Page 26
--------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
FIRST TRUST EXCHANGE-TRADED FUND III
OCTOBER 31, 2015 (UNAUDITED)
The Trust's statement of additional information includes additional information
about the Trustees and is available, without charge, upon request, by calling
(800) 988-5891.
NUMBER OF OTHER
PORTFOLIOS IN TRUSTEESHIPS OR
TERM OF OFFICE THE FIRST TRUST DIRECTORSHIPS
NAME, ADDRESS, AND YEAR FIRST FUND COMPLEX HELD BY TRUSTEE
DATE OF BIRTH AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING PAST
POSITION WITH THE TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
------------------------------------------------------------------------------------------------------------------------------------
Richard E. Erickson, Trustee o Indefinite Term Physician; President, Wheaton Orthopedics; 117 None
c/o First Trust Advisors L.P. Limited Partner, Gundersen Real Estate
120 East Liberty Drive, o Since Inception Limited Partnership; Member, Sportsmed LLC
Suite 400
Wheaton, IL 60187
D.O.B.: 04/51
Thomas R. Kadlec, Trustee o Indefinite Term President (March 2010 to Present), Senior 117 Director of ADM
c/o First Trust Advisors L.P. Vice President and Chief Financial Officer Investor Services,
120 East Liberty Drive, o Since Inception (May 2007 to March 2010), ADM Investor Inc., ADM
Suite 400 Services, Inc. (Futures Commission Investor Services
Wheaton, IL 60187 Merchant) International and Futures Industry
D.O.B.: 11/57 Association
Robert F. Keith, Trustee o Indefinite Term President (2003 to Present), Hibs 117 Director of Trust
c/o First Trust Advisors L.P. Enterprises (Financial and Management Company of
120 East Liberty Drive, o Since Inception Consulting) Illinois
Suite 400
Wheaton, IL 60187
D.O.B.: 11/56
Niel B. Nielson, Trustee o Indefinite Term Managing Director and Chief Operating 117 Director of
c/o First Trust Advisors L.P. Officer (January 2015 to Present), Pelita Covenant
120 East Liberty Drive, o Since Inception Harapan Educational Foundation Transport, Inc.
Suite 400 (Educational Products and Services); (May 2003 to
Wheaton, IL 60187 President and Chief Executive Officer May 2014)
D.O.B.: 03/54 (June 2012 to September 2014), Servant
Interactive LLC (Educational Products and
Services); President and Chief Executive
Officer (June 2012 to September 2014), Dew
Learning LLC (Educational Products and
Services); President (June 2002 to June
2012), Covenant College
------------------------------------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
James A. Bowen(1), Trustee, o Indefinite Term Chief Executive Officer (December 2010 to 117 None
Chairman of the Board Present), President (until December 2010),
120 East Liberty Drive, o Since Inception First Trust Advisors L.P. and First Trust
Suite 400 Portfolios L.P.; Chairman of the Board of
Wheaton, IL 60187 Directors, BondWave LLC (Software
D.O.B.: 09/55 Development Company/Investment Advisor
and Stonebridge Advisors LLC (Investment
Advisor)
-----------------------------
(1) Mr. Bowen is deemed an "interested person" of the Trust due to his
position as Chief Executive Officer of First Trust Advisors L.P.,
investment advisor of the Trust.
Page 27
--------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EXCHANGE-TRADED FUND III
OCTOBER 31, 2015 (UNAUDITED)
POSITION AND TERM OF OFFICE
NAME, ADDRESS OFFICES AND LENGTH OF PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH TRUST SERVICE DURING PAST 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES(2)
------------------------------------------------------------------------------------------------------------------------------------
Mark R. Bradley President and Chief o Indefinite Term Chief Operating Officer (December 2010 to Present)
120 E. Liberty Drive, Executive Officer and Chief Financial Officer, First Trust Advisors
Suite 400 o Since Inception L.P. and First Trust Portfolios L.P.; Chief Financial
Wheaton, IL 60187 Officer, BondWave LLC (Software Development
D.O.B.: 11/57 Company/Investment Advisor) and Stonebridge
Advisors LLC (Investment Advisor)
James M. Dykas Treasurer, Chief Financial o Indefinite Term Controller (January 2011 to Present), Senior Vice
120 E. Liberty Drive, Officer and Chief President (April 2007 to Present), First Trust
Suite 400 Accounting Officer o Since Inception Advisors L.P. and First Trust Portfolios L.P.
Wheaton, IL 60187
D.O.B.: 01/66
W. Scott Jardine Secretary and Chief o Indefinite Term General Counsel, First Trust Advisors L.P., First
120 E. Liberty Drive, Legal Officer Trust Portfolios L.P.; Secretary and General Counsel,
Suite 400 o Since Inception BondWave LLC (Software Development Company/
Wheaton, IL 60187 Investment Advisor) and Secretary, Stonebridge
D.O.B.: 05/60 Advisors LLC (Investment Advisor)
Daniel J. Lindquist Vice President o Indefinite Term Managing Director (July 2012 to Present), Senior
120 E. Liberty Drive, Vice President (September 2005 to July 2012),
Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios
Wheaton, IL 60187 L.P.
D.O.B.: 02/70
Kristi A. Maher Chief Compliance Officer o Indefinite Term Deputy General Counsel, First Trust Advisors
120 E. Liberty Drive, and Assistant Secretary L.P. and First Trust Portfolios L.P.
Suite 400 o Since Inception
Wheaton, IL 60187
D.O.B.: 12/66
Roger F. Testin Vice President o Indefinite Term Senior Vice President, First Trust Advisors L.P.
120 E. Liberty Drive, and First Trust Portfolios L.P.
Suite 400 o Since Inception
Wheaton, IL 60187
D.O.B.: 06/66
Stan Ueland Vice President o Indefinite Term Senior Vice President (September 2012 to Present),
120 E. Liberty Drive, Vice President (August 2005 to September 2012),
Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios
Wheaton, IL 60187 L.P.
D.O.B.: 11/70
-----------------------------
(2) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 28
--------------------------------------------------------------------------------
PRIVACY POLICY
--------------------------------------------------------------------------------
FIRST TRUST PREFERRED SECURITIES AND INCOME ETF (FPE)
OCTOBER 31, 2015 (UNAUDITED)
PRIVACY POLICY
First Trust values our relationship with you and considers your privacy an
important priority in maintaining that relationship. We are committed to
protecting the security and confidentiality of your personal information.
SOURCES OF INFORMATION
We collect nonpublic personal information about you from the following sources:
o Information we receive from you and your broker-dealer, investment
advisor or financial representative through interviews,
applications, agreements or other forms;
o Information about your transactions with us, our affiliates or
others;
o Information we receive from your inquiries by mail, e-mail or
telephone; and
o Information we collect on our website through the use of "cookies".
For example, we may identify the pages on our website that your
browser requests or visits.
INFORMATION COLLECTED
The type of data we collect may include your name, address, social security
number, age, financial status, assets, income, tax information, retirement and
estate plan information, transaction history, account balance, payment history,
investment objectives, marital status, family relationships and other personal
information.
DISCLOSURE OF INFORMATION
We do not disclose any nonpublic personal information about our customers or
former customers to anyone, except as permitted by law. In addition to using
this information to verify your identity (as required under law), the permitted
uses may also include the disclosure of such information to unaffiliated
companies for the following reasons:
o In order to provide you with products and services and to effect
transactions that you request or authorize, we may disclose your
personal information as described above to unaffiliated financial
service providers and other companies that perform administrative or
other services on our behalf, such as transfer agents, custodians
and trustees, or that assist us in the distribution of investor
materials such as trustees, banks, financial representatives, proxy
services, solicitors and printers.
o We may release information we have about you if you direct us to do
so, if we are compelled by law to do so, or in other legally limited
circumstances (for example to protect your account from fraud).
In addition, in order to alert you to our other financial products and services,
we may share your personal information within First Trust.
PRIVACY ONLINE
We allow third-party companies, including AddThis (a social media sharing
service), to collect certain anonymous information when you visit our website.
These companies may use non-personally identifiable information during your
visits to this and other websites in order to provide advertisements about goods
and services likely to be of greater interest to you. These companies typically
use a cookie, third party web beacon or pixel tags, to collect this information.
To learn more about this behavioral advertising practice, you can visit
www.networkadvertising.org.
CONFIDENTIALITY AND SECURITY
With regard to our internal security procedures, First Trust restricts access to
your nonpublic personal information to those First Trust employees who need to
know that information to provide products or services to you. We maintain
physical, electronic and procedural safeguards to protect your nonpublic
personal information.
POLICY UPDATES AND INQUIRIES
As required by federal law, we will notify you of our privacy policy annually.
We reserve the right to modify this policy at any time, however, if we do change
it, we will tell you promptly. For questions about our policy, or for additional
copies of this notice, please go to www.ftportfolios.com, or contact us at
1-800-621-1675 (First Trust Portfolios) or 1-800-222-6822 (First Trust
Advisors).
Page 29
This page intentionally left blank.
This page intentionally left blank.
This page intentionally left blank.
FIRST TRUST
First Trust Exchange-Traded Fund III
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
INVESTMENT SUB-ADVISOR
Stonebridge Advisors LLC
187 Danbury Road
Wilton, CT 06897
ADMINISTRATOR, CUSTODIAN,
FUND ACCOUNTANT &
TRANSFER AGENT
Brown Brothers Harriman & Co.
50 Post Office Square
Boston, MA 02110
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]
FIRST TRUST
First Trust Exchange-Traded Fund III
------------------------------------
First Trust Managed Municipal ETF (FMB)
Annual Report
For the
Year Ended
October 31, 2015
--------------------------------------------------------------------------------
TABLE OF CONTENTS
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
ANNUAL REPORT
OCTOBER 31, 2015
Shareholder Letter......................................................... 1
Fund Performance Overview.................................................. 2
Portfolio Commentary....................................................... 5
Understanding Your Fund Expenses........................................... 7
Portfolio of Investments................................................... 8
Statement of Assets and Liabilities........................................ 13
Statement of Operations.................................................... 14
Statements of Changes in Net Assets........................................ 15
Financial Highlights....................................................... 16
Notes to Financial Statements.............................................. 17
Report of Independent Registered Public Accounting Firm.................... 22
Additional Information..................................................... 23
Board of Trustees and Officers............................................. 27
Privacy Policy............................................................. 29
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 its 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
the series of First Trust Exchange-Traded Fund III (the "Trust") described in
this report (First Trust Managed Municipal ETF; hereinafter referred to as 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 its 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 Additional
Information section of this report 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 share price will fluctuate and Fund shares, when
sold, may be worth more or less than their original cost.
The Advisor may also periodically provide additional information on Fund
performance on the Fund's webpage at http://www.ftportfolios.com.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment in
the Fund. It includes details about the Fund's portfolio 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 the
Advisor 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 material risks of investing in the
Fund are spelled out in its prospectus, statement of additional information,
this report and other Fund regulatory filings.
--------------------------------------------------------------------------------
SHAREHOLDER LETTER
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
ANNUAL LETTER FROM THE CHAIRMAN AND CEO
OCTOBER 31, 2015
Dear Shareholders:
Thank you for your investment in First Trust Managed Municipal ETF (the "Fund").
First Trust Advisors L.P. ("First Trust") is pleased to provide you with the
annual report which contains detailed information about your investment for the
12 months ended October 31, 2015, including a market overview and a performance
analysis for the period. We encourage you to read this report and discuss it
with your financial advisor.
U.S. markets, fueled by accelerating growth and an accommodating Federal
Reserve, enjoyed a prosperous year in 2014. However, most of 2015 has been
volatile. Economic and global factors, such as the continued conflict in the
Middle East, a sharp decline in oil prices and terrorism around the world, have
impacted U.S. and global markets. Another factor that has weighed upon U.S.
markets for most of the year is the fact that many economists had predicted that
the Federal Reserve would begin to raise interest rates in 2015, which has still
not happened.
As I have written previously, First Trust believes investors should maintain
perspective about the markets and have realistic expectations about their
investments. Markets will always go up and down, but we believe that having a
long-term investment horizon and being invested in quality products can help you
reach your goals.
Thank you for giving First Trust the opportunity to be a part of your investment
plan. We value the relationship and will continue to focus on our disciplined
investment approach and long-term perspective to help investors reach their
financial goals.
Sincerely,
/s/ James A. Bowen
James A. Bowen
Chairman of the Board of Trustees
Chief Executive Officer of First Trust Advisors L.P.
Page 1
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
The primary investment objective of First Trust Managed Municipal ETF (the
"Fund") is to generate current income that is exempt from regular federal income
taxes, and its secondary objective is long-term capital appreciation. The Fund
lists and principally trades its shares on The NASDAQ(R) Stock Market, LLC under
the ticker symbol "FMB". Under normal market conditions, the Fund seeks to
achieve its investment objectives by investing at least 80% of its net assets
(plus the amount of any borrowings for investment purposes) in municipal debt
securities that pay interest that is exempt from regular federal income taxes.
-------------------------------------------------------------------------------------------------------------------
PERFORMANCE
-------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL CUMULATIVE
1 Year TOTAL RETURNS TOTAL RETURNS
Ended Inception (5/13/14) Inception (5/13/14)
10/31/15 to 10/31/15 to 10/31/15
FUND PERFORMANCE
NAV 3.66% 4.93% 7.32%
Market Price 3.17% 5.11% 7.59%
INDEX PERFORMANCE
Barclays Municipal 10-Year Revenue Index 2.82% 3.96% 5.87%
-------------------------------------------------------------------------------------------------------------------
Total returns for the period since inception are calculated from the inception
date of the Fund. "Average Annual Total Returns" represent the average annual
change in value of an investment over the period indicated. "Cumulative Total
Returns" represent the total change in value of an investment over the period
indicated.
The Fund's per share net asset value ("NAV") is the value of one share of the
Fund and is computed by dividing the value of all assets of the Fund (including
accrued interest and dividends), less all liabilities (including accrued
expenses and dividends declared but unpaid), by the total number of outstanding
shares. The price used to calculate market return ("Market Price") is determined
by using the midpoint between the highest bid and the lowest offer on the stock
exchange on which shares of the Fund are listed for trading as of the time that
the Fund's NAV is calculated. Since shares of the Fund did not trade in the
secondary market until after its inception, for the period from inception to the
first day of secondary market trading in shares of the Fund, the NAV of the Fund
is used as a proxy for the secondary market trading price to calculate market
returns. NAV and market returns assume that all distributions have been
reinvested in the Fund at NAV and Market Price, respectively.
An index is a statistical composite that tracks a specified financial market or
sector. Unlike the Fund, the index does not actually hold a portfolio of
securities and therefore does not incur the expenses incurred by the Fund. These
expenses negatively impact the performance of the Fund. Also, market returns do
not include brokerage commissions that may be payable on secondary market
transactions. If brokerage commissions were included, market returns would be
lower. The total returns presented reflect the reinvestment of dividends on
securities in the index. The returns presented do not reflect the deduction of
taxes that a shareholder would pay on Fund distributions or the redemption or
sale of Fund shares. The investment return and principal value of shares of the
Fund will vary with changes in market conditions. Shares of the Fund may be
worth more or less than their original cost when they are redeemed or sold in
the market. The Fund's past performance is no guarantee of future performance.
Page 2
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
-----------------------------------------------------------
SECTOR ALLOCATION AS OF OCTOBER 31, 2015
-----------------------------------------------------------
% OF TOTAL
INVESTMENTS
SECTOR (INCLUDING CASH)
Continuing Care Retirement Communities 16.8%
Hospital 14.0
Insured 10.5
Cash 9.2
Government Obligation Bond - Unlimited Tax 6.3
Dedicated Tax 5.8
Gas 5.0
Utility 4.6
Education 3.8
Government Obligation Bond - Limited Tax 3.7
Higher Education 3.6
Special Assessment 3.3
Industrial Development Bond 2.6
Student Housing 2.3
Airport 2.0
Mass Transit 1.9
Certificates of Participation 1.3
Tax Increment 1.0
Tobacco 0.8
Pre-refunded/Escrowed-to-maturity 0.8
Port 0.7
-------
Total 100.0%
=======
-----------------------------------------------------------
CREDIT QUALITY AS OF OCTOBER 31, 2015
-----------------------------------------------------------
% OF TOTAL
INVESTMENTS
CREDIT RATING(1) (INCLUDING CASH)
AA 17.8%
A 28.4
BBB 20.6
BB 8.7
B 0.8
Not Rated 14.5
Cash 9.2
-------
Total 100.0%
=======
(1) The credit quality information presented 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 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 creditworthiness of the issuers of the
underlying securities in the Fund, and not to the Fund or its shares.
Credit ratings are subject to change.
Page 3
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
PERFORMANCE OF A $10,000 INITIAL INVESTMENT
MAY 13, 2014 - OCTOBER 31, 2015
First Trust Managed Barclays Municipal
Municipal ETF 10-Year Revenue Index
5/13/14 $10,000 $10,000
10/31/14 10,353 10,297
4/30/15 10,585 10,392
10/31/15 10,732 10,588
Performance figures assume reinvestment of all distributions and do not reflect
the deduction of taxes that a shareholder would pay on Fund distributions or the
redemption or sale of Fund shares. An index is a statistical composite that
tracks a specified financial market or sector. Unlike the Fund, the index does
not actually hold a portfolio of securities and therefore does not incur the
expenses incurred by the Fund. These expenses negatively impact the performance
of the Fund. The Fund's past performance does not predict future performance.
FREQUENCY DISTRIBUTION OF DISCOUNTS AND PREMIUMS
BID/ASK MIDPOINT VS. NAV THROUGH OCTOBER 31, 2015
The following Frequency Distribution of Discounts and Premiums charts are
provided to show the frequency at which the bid/ask midpoint price for the Fund
was at a discount or premium to the daily NAV. The following tables are for
comparative purposes only and represent the period May 14, 2014 (commencement of
trading) through October 31, 2015. Shareholders may pay more than NAV when they
buy Fund shares and receive less than NAV when they sell those shares because
shares are bought and sold at current market price. Data presented represents
past performance and cannot be used to predict future results.
------------------------------------------------------------------------------
NUMBER OF DAYS BID/ASK MIDPOINT AT/ABOVE NAV
------------------------------------------------------------------------------
FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00%
5/14/14 - 10/31/14 2 10 0 0
11/1/14 - 10/31/15 178 16 0 0
------------------------------------------------------------------------------
NUMBER OF DAYS BID/ASK MIDPOINT BELOW NAV
------------------------------------------------------------------------------
FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00%
5/14/14 - 10/31/14 64 43 0 0
11/1/14 - 10/31/15 57 0 0 0
Page 4
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
ANNUAL REPORT
OCTOBER 31, 2015
INVESTMENT MANAGER
The First Trust Advisors L.P. ("First Trust") Municipal Securities Team was
formed in September of 2013 and is headed by Tom Futrell, CFA, and Johnathan
Wilhelm, who serve as senior portfolio managers of the First Trust Managed
Municipal ETF (the "Fund"). Messrs. Futrell and Wilhelm have a combined 50+
years of investment experience and prior to joining First Trust, served as
portfolio managers of municipal bonds at Nuveen Investments and Performance
Trust Investment Advisors. In addition to the Fund, the team manages/consults
for a variety of investment portfolios and separately managed accounts.
PORTFOLIO MANAGEMENT TEAM
TOM FUTRELL, CFA, SENIOR VICE PRESIDENT, SENIOR PORTFOLIO MANAGER
JOHNATHAN N. WILHELM, SENIOR VICE PRESIDENT, SENIOR PORTFOLIO MANAGER
COMMENTARY
MARKET RECAP
For the 12-month period from October 31, 2014 through October 31, 2015,
municipal bonds generated a total return of 2.87% as measured by the Barclays
Municipal Bond Index (BMBI). During the same period, the Barclays 10-Year
Revenue Bond Index and Barclays Non-Investment Grade Index produced returns of
3.27% and 2.85%, respectively. By comparison, the Barclays U.S. Treasury Index
returned 2.39% during the 12-month period. The following have been major factors
in explaining the municipal bond market's performance:
o Global macroeconomic uncertainty, geopolitical tensions and moderate
improvements in U.S. economic fundamentals were juxtaposed against a
general market consensus that believed rates would rise in
anticipation of a possible Federal Reserve tightening. Consensus was
wrong, the Federal Reserve has not yet tightened, but there has been
volatility in Treasury rates as a consequence, with little net
change. As of October 31, 2015, the 10-year U.S. Treasury yield
stood at approximately 2.14%, down 21 basis points for the trailing
12 months, and down just three basis points year-to-date. Ten-year
municipal yields as measured by 10-year, "AAA" rated general
obligation bonds fell just three basis points during the same
period, according to data prepared by Municipal Market Data (MMD),
to 2.01% as of October 31, 2015.
o The technical environment for the municipal market was less
supportive and contributed to softer total returns during the year
versus those in 2014. Primary market new issuance through the end of
October totaled $349.2 billion versus $268.9 billion during the same
period the prior year, a 29.9% increase. On the demand side of the
equation, net mutual fund flows started the year strong, but turned
modestly negative for five consecutive months. The pace of outflows
slowed substantially late in September after the Federal Open Market
Committee ("FOMC" or the "Fed") announced it would not raise rates
and investor worry surrounding higher yields subsided to some
extent. Although mutual fund flows turned positive in October,
demand for the year is significantly lower than that in the prior
year, as total net inflows year-to-date through October 31, 2015
were just $5.0 billion compared to $20.6 billion year-to-date
through October 31, 2014, a decrease of 76%. (Source: Barclays,
Investment Company Institute)
o The municipal credit environment remained healthy on improving U.S.
credit fundamentals despite negative press regarding certain
high-profile municipal issuers. Not only had state and local
government tax revenues continued their upward trend through the
first six months of 2015, but year-to-date through October 31, 2015,
data prepared by Municipal Market Advisors (MMA) showed that 43
borrowers had defaulted on a par value of $3.66 billion compared to
51 defaults on a par value of $9.23 billion during the same period a
year ago. In spite of the negative headlines regarding certain
troubled credits, including the Commonwealth of Puerto Rico and the
City of Chicago, we expect credit fundamentals generally to remain
stable.
PERFORMANCE ANALYSIS
The Fund's net asset value ("NAV") and market performance for the 12-month
period from October 31, 2014 through October 31, 2015 was 3.66% and 3.17%,
respectively, versus the Barclays Municipal 10-Year Revenue Index (the
"benchmark") return of 2.82% during the same time period.
The Fund's monthly distribution of $0.1150 on October 30, 2015, represented a
tax-exempt annualized distribution rate of 2.67% (4.72% taxable equivalent
yield(1)) based on the Fund's closing market price of $51.77. The Fund's
distribution rate is not constant and is subject to change over time based on
the performance of the Fund and general market conditions.
From a portfolio construction perspective, the Fund maintains an underweight
position in the highest quality issuers (AA rated and higher) in the benchmark
and is generally overweight the benchmark in terms of BBB and BB rated exposure.
The Fund may allocate up to 35% of its net assets to credits that are either
rated below investment grade or are non-rated and deemed to be of comparable
-----------------------------
(1) The taxable equivalent yield is based on the highest federal income tax
bracket for 2015 and the Medicare surtax of 3.8%.
Page 5
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
ANNUAL REPORT
OCTOBER 31, 2015
quality at the time of purchase. We believe these bonds tend to carry higher
income cushions than their high-quality counterparts, which can help insulate
the investment against interest rate risk without materially increasing default
potential. As of October 31, 2015, the Fund's weighted-average credit quality
was approximately BBB/Baa, which is lower than the benchmark with a stated
average credit rating of AA3/A1. The Fund's investments in BBB rated bonds as
well as sub-investment grade and non-rated municipal securities, generated
strong performance for the period, as investors increasingly searched for yield
lower on the credit rating spectrum given the low nominal rates environment. As
a result, lower investment-grade strategies generally benefited from credit
spread compression during the year, positively contributing to the Fund's NAV
outperformance relative to the benchmark.
We also see value in revenue bonds issued by essential service providers. We
believe these investments carry upside potential that allows us to take
advantage of the positive economic environment and potential credit spread
compression, which could lead to enhanced portfolio returns over time. In fact,
the revenue bond sectors that positively contributed to the Fund's performance
over the past 12 months included hospitals, education (charter schools),
municipal utilities, power, transportation and special assessment districts.
The Fund's modified duration was 5.64 as of October 31, 2015, which was shorter
than the benchmark's at 5.82. Bonds in the 5- to 6-year modified duration
category were the only detractor to the Fund's total return over the 12-month
period; bonds in the 4- to 5-year category, as well as 6 years and beyond were
additive to the Fund's performance. Because we believe that the very short end
of the municipal yield curve could be the most vulnerable to the volatility
associated with a Federal Reserve rate hike, we have limited the Fund's exposure
to bonds that mature in 1 to 4 years.
MARKET OUTLOOK
Looking to the year ahead, the Fed's decision in October to postpone "lift-off"
coupled with weaker economic data has created a murky path forward and has
reduced our confidence in a rate hike before year-end. While the Fed's rhetoric
makes it clear that a policy shift remains in play for 2015, upward action on
rates is expected to be highly data dependent. In 2016, we do expect U.S.
Treasury yields to modestly rise, as the economy gains strength and as the Fed
ultimately starts to tighten.
Following a year of robust municipal bond issuance in which current and advance
refundings made up over 60% of the volume, we expect issuance in the year ahead
to be similar to 2015, even if the pace of refunding activity is apt to slow
down. Because of a persistently low interest rate environment and the growing
need to repair and expand U.S. infrastructure such as airports, bridges,
electric utilities, roads and water systems, we would expect new issue municipal
bond supply to be between $375 billion and $415 billion in 2016.
We will continue to position the portfolio defensively by being modestly below
its benchmark duration given our expectation for gradually rising rates. Because
we believe yield curve positioning could be an important source of total return
in 2016, our current intention is to underweight bonds in the short end of the
municipal yield curve as they could be the most vulnerable to volatility
associated with Fed tightening, and underweight long-duration bonds that could
be negatively impacted in a rising-rate environment. We currently favor bonds
with 6 to 9 year maturities, and bonds maturing in 12 to 20 years, but priced to
a shorter 6 to 9 year call. We also favor 5% coupon bonds, versus 3% and 4%
coupon structures, that together with our preferred yield curve positioning
serves to reduce overall portfolio duration. On the credit side, we continue to
over-weight A rated and select BBB rated and high yield municipal securities,
given a healthy fundamental credit picture, which we believe supports reaching
lower on the credit spectrum. We also continue to find pockets of investment
opportunity in the essential service revenue bond sectors such as health care,
senior living, education, transportation, and utilities, where, in our view,
there is additional default-risk insulation because of the borrowers'
essentiality in their local communities.
What are the risks to our outlook and forecast of a gradual rise in interest
rates? Among many factors, stronger than expected GDP growth and an uptick in
inflation, a substantive change in Federal Reserve commentary regarding 2016
monetary policy, higher than forecast municipal bond new issue supply, and large
mutual fund net outflows could alter our forecast. In addition, weaker than
expected economic growth in the European Union, China and Japan along with
continued outbreaks of elevated global conflicts could keep domestic interest
rates lower for a longer period of time than we forecast. With this as a
backdrop, we will continue to practice the discipline of our investment process
where we perform fundamental credit analysis and quantitative total return
scenario analysis on individual bonds and the portfolio as a whole, looking for
bonds that can provide both high income and attractive total return potential
over time.
Page 6
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
UNDERSTANDING YOUR FUND EXPENSES
OCTOBER 31, 2015 (UNAUDITED)
As a shareholder of First Trust Managed Municipal ETF (the "Fund") you incur two
types of costs: (1) transaction costs; and (2) ongoing costs, including
management fees, distribution and/or service fees, if any, and other Fund
expenses. This Example is intended to help you understand your ongoing costs of
investing in the Fund and to compare these costs with the ongoing costs of
investing in other funds.
The Example is based on an investment of $1,000 invested at the beginning of the
period and held through the six-month period ended October 31, 2015.
ACTUAL EXPENSES
The first line in the following table provides information about actual account
values and actual expenses. You may use the information in this line, together
with the amount you invested, to estimate the expenses that you paid over the
period. Simply divide your account value by $1,000 (for example, an $8,600
account value divided by $1,000 = 8.6), then multiply the result by the number
in the first line under the heading entitled "Expenses Paid During the Six-Month
Period" to estimate the expenses you paid on your account during this six-month
period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line in the following table provides information about hypothetical
account values and hypothetical expenses based on the Fund's actual expense
ratio and an assumed rate of return of 5% per year before expenses, which is not
the Fund's actual return. The hypothetical account values and expenses may not
be used to estimate the actual ending account balance or expenses you paid for
the period. You may use this information to compare the ongoing costs of
investing in the Fund and other funds. To do so, compare this 5% hypothetical
example with the 5% hypothetical examples that appear in the shareholder reports
of the other funds.
Please note that the expenses shown in the table are meant to highlight your
ongoing costs only and do not reflect any transactional costs such as brokerage
commissions. Therefore, the second line in the table is useful in comparing
ongoing costs only, and will not help you determine the relative total costs of
owning different funds. In addition, if these transactional costs were included,
your costs would have been higher.
-------------------------------------------------------------------------------------------------------------------------
ANNUALIZED
EXPENSE RATIO EXPENSES PAID
BEGINNING ENDING BASED ON THE DURING THE
ACCOUNT VALUE ACCOUNT VALUE SIX-MONTH SIX-MONTH
MAY 1, 2015 OCTOBER 31, 2015 PERIOD PERIOD (a)
-------------------------------------------------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF
Actual $1,000.00 $1,013.90 0.65% $3.30
Hypothetical (5% return before expenses) $1,000.00 $1,021.93 0.65% $3.31
(a) Expenses are equal to the annualized expense ratio as indicated in the
table, multiplied by the average account value over the period (May 1,
2015 through October 31, 2015), multiplied by 184/365 (to reflect the
one-half year period).
Page 7
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 2015
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
MUNICIPAL BONDS - 95.1%
ARIZONA - 0.7%
$ 200,000 Student & Academic Svcs LLC AZ Lease Rev Northern AZ
Capital Facs Fin Corp, BAM.................................... 5.00% 06/01/21 $ 232,188
------------
CALIFORNIA - 6.0%
320,000 Abag CA Fin Auth For Nonprofit Corps Ref Episcopal Sr Cmntys,
Ser B......................................................... 5.00% 07/01/23 359,382
75,000 CA St Hlth Facs Fing Auth Rev Ref Insd Marshall Med Ctr, CA
MTG INS....................................................... 5.00% 11/01/25 90,552
250,000 CA Stwd Cmntys Dev Auth Rev Ref Insd Enloe Med Ctr, CA
MTG INS....................................................... 5.00% 08/15/34 287,128
250,000 CA Stwd Cmntys Dev Auth Rev Ref Insd Enloe Med Ctr, CA
MTG INS....................................................... 5.00% 08/15/35 286,193
275,000 Golden St Tobacco Securitization Corp. CA Tobacco Settlement
Asset-Backed Sr, Ser A-1...................................... 4.50% 06/01/27 268,683
210,000 La Verne CA Ref Brethren Hillcrest Homes, COP.................... 5.00% 05/15/22 234,870
400,000 San Francisco City & Cnty CA Cops Port Facs Proj, Ser C,
AMT, COP...................................................... 5.00% 03/01/22 473,040
------------
1,999,848
------------
COLORADO - 7.0%
605,000 CO St Hlth Facs Auth Rev Ref Covenant Retirement Cmntys,
Ser A......................................................... 5.00% 12/01/27 656,292
120,000 CO St Hlth Facs Auth Rev Vail Valley Med Ctr Proj................ 5.00% 01/15/24 141,716
200,000 CO St Hlth Facs Auth Rev Vail Valley Med Ctr Proj................ 5.00% 01/15/35 225,898
500,000 Copperleaf CO Met Dist #2 Ref (a)................................ 5.25% 12/01/30 517,945
55,000 E-470 CO Pub Highway Auth Capital Appreciation Sr, Ser B,
NATL-RE....................................................... (b) 09/01/22 46,079
250,000 Harvest Junction CO Met Dist Ref & Impt.......................... 5.00% 12/01/30 267,490
500,000 Promenade Castle Rock CO Met Dist #1, Ser A (a).................. 5.13% 12/01/25 501,915
------------
2,357,335
------------
FLORIDA - 5.5%
225,000 Belle Isle FL Chrt Sch Lease Rev Cornerstone Chrt Academy &
Cornerstone Chrt High Sch..................................... 5.50% 10/01/22 231,228
605,000 Broward Cnty FL Fuel Sys Rev Ft Lauderdale Fuel Facs, Ser A,
AGM, AMT (c).................................................. 5.00% 04/01/22 707,299
250,000 Citizens Property Insurance Corp. FL, Ser A-1.................... 5.00% 06/01/22 293,638
25,000 Escambia Cnty FL Hlth Facs Auth Baptist Hosp Inc. Proj, Ser A.... 5.00% 08/15/19 27,930
265,000 Escambia Cnty FL Hlth Facs Auth Baptist Hosp Inc. Proj, Ser A.... 5.50% 08/15/24 302,656
50,000 Hollywood FL Cmnty Redev Agy Redev Rev Ref....................... 5.00% 03/01/23 57,847
220,000 Palm Beach Cnty FL Hlth Facs Auth Acts Retirement Life
Cmntys........................................................ 5.50% 11/15/33 239,602
------------
1,860,200
------------
GEORGIA - 0.8%
250,000 East Point GA Tax Allocation Ref................................. 5.00% 08/01/21 281,658
------------
GUAM - 3.3%
630,000 Guam Govt Business Privilege Tax Rev Ref, Ser D.................. 5.00% 11/15/22 726,560
325,000 Guam Power Auth Rev Ref, Ser A, AGM (c).......................... 5.00% 10/01/20 376,207
------------
1,102,767
------------
Page 8 See Notes to Financial Statements
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
MUNICIPAL BONDS (CONTINUED)
HAWAII - 0.9%
$ 170,000 HI St Dept of Budget & Fin Spl Purpose Rev Ref HI Pacific Hlth
Oblig Group, Ser B............................................ 5.00% 07/01/30 $ 190,631
110,000 HI St Pacific Hlth Spl Purpose Rev, Ser B........................ 5.63% 07/01/30 126,960
------------
317,591
------------
IDAHO - 1.6%
500,000 ID St Hlth Facs Auth Rev Trinity Hlth Ref, Ser D................. 5.00% 12/01/33 552,350
------------
ILLINOIS - 4.0%
40,000 Chicago IL Ref Projs, Ser A...................................... 5.00% 01/01/21 40,748
100,000 Chicago IL Ref Projs, Ser A...................................... 5.00% 01/01/24 100,739
25,000 Chicago IL Ref, Ser C............................................ 4.00% 01/01/22 23,700
240,000 Chicago IL Ref, Ser C............................................ 4.00% 01/01/24 222,547
90,000 Chicago IL, Ser D................................................ 4.30% 01/01/24 85,238
100,000 IL St Fin Auth Rev Centegra Hlth Sys............................. 5.00% 09/01/18 108,744
145,000 IL St Fin Auth Rev Centegra Hlth Sys, Ser A...................... 5.00% 09/01/22 166,238
25,000 IL St Fin Auth Rev Central Dupage Hlth........................... 5.00% 11/01/27 28,254
15,000 IL St Fin Auth Rev Ref Lutheran Hillside Village................. 5.13% 02/01/26 15,391
500,000 IL St Fin Auth Rev Ref Plymouth Place............................ 5.00% 05/15/25 535,810
------------
1,327,409
------------
INDIANA - 2.1%
350,000 IN St Fin Auth Rev BHI Sr Living................................. 5.50% 11/15/26 389,970
250,000 IN St Fin Auth Rev Greencroft Oblig Group, Ser A................. 5.75% 11/15/28 272,093
40,000 IN St Fin Auth Rev Greencroft Oblig Group, Ser A................. 6.00% 11/15/28 44,204
------------
706,267
------------
IOWA - 0.3%
100,000 IA St Fin Auth Midwestern Disaster Area Rev IA Fertilizer Co
Proj.......................................................... 5.50% 12/01/22 106,080
------------
KENTUCKY - 1.0%
300,000 KY St Muni Pwr Agy Pwr Sys Rev Ref, Ser A, NATL-RE............... 5.00% 09/01/22 350,676
------------
LOUISIANA - 2.6%
390,000 LA Stadium & Exposition Dist LA Ref Sr, Ser A.................... 5.00% 07/01/30 441,008
380,000 LA Stadium & Exposition Dist LA Ref Sr, Ser A.................... 5.00% 07/01/31 428,868
------------
869,876
------------
MARYLAND - 0.7%
220,000 MD St Econ Dev Corp Econ Dev Rev Transn Facs Proj, Ser A......... 5.38% 06/01/25 240,601
------------
MICHIGAN - 0.7%
100,000 MI St Fin Auth Rev Detroit Sch Dist.............................. 5.50% 06/01/21 107,194
125,000 MI St Fin Auth Rev Ref Local Govt Loan Program, Ser F1........... 3.88% 10/01/23 129,260
------------
236,454
------------
MINNESOTA - 5.5%
460,000 Hugo MN Chrt Sch Lease Rev Noble Academy Proj, Ser A............. 4.00% 07/01/21 473,124
250,000 Minneapolis MN Student Hsg Rev Riverton Cmnty Hsg Proj Ref....... 3.50% 08/01/20 250,425
500,000 Rochester MN Hlth Care & Hsg Rev Fac Homestead Rochester
Inc Proj, Ser A............................................... 5.00% 12/01/25 533,070
600,000 Rochester MN Hlth Care & Hsg Rev Fac Homestead Rochester
Inc Proj, Ser A............................................... 5.00% 12/01/49 587,496
------------
1,844,115
------------
See Notes to Financial Statements Page 9
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
MUNICIPAL BONDS (CONTINUED)
MISSISSIPPI - 2.1%
$ 615,000 MS St Dev Bank Spl Oblig Magnolia Regl Hlth Ctr Proj, Ser A...... 6.00% 10/01/24 $ 707,010
------------
MISSOURI - 2.4%
200,000 MO St Hlth & Edl Facs Auth Edl Facs Rev St Louis Clg
Pharmacy, Ser B............................................... 5.00% 05/01/30 216,264
550,000 MO St Hlth & Edl Facs Auth Sr Living Facs Lutheran Sr............ 5.38% 02/01/35 585,601
------------
801,865
------------
NEBRASKA - 3.2%
950,000 Central Plains Energy Proj NE Gas Proj Rev Proj #3............... 5.00% 09/01/27 1,063,325
------------
NEVADA - 1.6%
490,000 Las Vegas NV Spl Impt Dist #808 & #810 Ref....................... 5.00% 06/01/22 523,913
------------
NEW JERSEY - 2.3%
80,000 NJ St Hlth Care Facs Fing Auth Rev Ref Barnabas Hlth, Ser A...... 4.63% 07/01/23 89,408
600,000 NJ St Transit Corp, Ser A, GAN................................... 5.00% 09/15/21 680,976
------------
770,384
------------
NEW YORK - 1.3%
100,000 Buffalo & Erie Cnty NY Indl Land Dev Corp Rev Ref Orchard
Park.......................................................... 5.00% 11/15/22 110,193
115,000 Buffalo & Erie Cnty NY Indl Land Dev Corp Rev Ref Orchard
Park.......................................................... 5.00% 11/15/24 126,758
85,000 NY St Dorm Auth Revs Non St Supported Debt Pace Univ, Ser A...... 5.00% 05/01/23 93,927
100,000 Suffolk Cnty NY Econ Dev Corp Rev Catholic Hlth Svcs............. 5.00% 07/01/28 109,733
------------
440,611
------------
NORTH CAROLINA - 3.1%
900,000 NC St Capital Facs Fin Agy Student Rev Ref Hsg NC A&T Univ
Fndtn Proj, Ser A, AGM (c).................................... 5.00% 06/01/26 1,024,326
------------
NORTH DAKOTA - 0.8%
225,000 Burleigh Cnty ND Hlth Care Rev St Alexius Med Ctr Proj, Ser A.... 5.00% 07/01/22 268,236
------------
OHIO - 0.7%
230,000 Southeastern OH Port Auth Hosp Facs Rev Ref Mem Hlth Sys......... 5.00% 12/01/23 243,938
------------
OKLAHOMA - 0.3%
100,000 Tulsa OK Arpts Impt Trust Ref, Ser D, BAM........................ 5.00% 06/01/28 108,221
------------
OREGON - 0.9%
275,000 Multnomah Cnty OR Hosp Facs Auth Rev Ref Terwilliger Plaza....... 5.00% 12/01/20 301,059
------------
PENNSYLVANIA - 7.6%
500,000 Beaver Cnty PA Indl Dev Auth Ref Firstenergy Nuclear, Ser B (d).. 3.50% 06/01/20 507,820
225,000 Dallas PA Area Muni Auth Univ Rev Ref Misericordia Univ Proj..... 5.00% 05/01/21 245,839
500,000 Middletown PA Sch Dist, Ser A.................................... 5.00% 03/01/28 572,065
50,000 Montgomery Cnty PA Indl Dev Auth Acts Retirement Life
Cmntys Ref.................................................... 5.00% 11/15/29 53,620
500,000 PA St, 1st Ser................................................... 5.00% 03/15/23 595,810
500,000 Philadelphia PA, Ser B........................................... 5.00% 08/01/23 588,240
------------
2,563,394
------------
PUERTO RICO - 0.5%
190,000 Puerto Rico Indl Tourist Edl Med & Envir Control Fac Ref Univ
Sacred Heart (a).............................................. 5.00% 10/01/22 153,423
------------
Page 10 See Notes to Financial Statements
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
PRINCIPAL STATED STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
----------- ----------------------------------------------------------------- ------------- ---------- ------------
MUNICIPAL BONDS (CONTINUED)
SOUTH CAROLINA - 3.1%
$ 745,000 Piedmont SC Muni Power Agy Elec Rev Ref, Ser A-3................. 5.00% 01/01/23 $ 853,614
150,000 SC St Jobs-Econ Dev Auth Hosp Rev Ref Palmetto Hlth, Ser A,
AGM (c)....................................................... 5.50% 08/01/24 178,788
------------
1,032,402
------------
SOUTH DAKOTA - 0.1%
30,000 SD St Hlth & Edl Facs Auth Avera Hlth, Ser B..................... 5.50% 07/01/35 32,778
------------
TENNESSEE - 2.1%
600,000 Memphis Shelby Cnty TN Arpt Auth Arpt Rev Ref, Ser B, AMT........ 5.75% 07/01/23 697,266
------------
TEXAS - 10.6%
600,000 Flower Mound TX Spl Assmt Rev River Walk Pub Impt Dist #1........ 6.13% 09/01/28 620,220
500,000 Houston TX Arpt Sys Rev Ref United Airls Inc. Terminal E Proj,
AMT........................................................... 4.50% 07/01/20 523,930
255,000 Love Field TX Arpt Modernization Corp Spl Facs Rev Southwest
Airls Co Proj................................................. 5.00% 11/01/28 280,365
290,000 New Hope Cultural Ed Facs Fin Corp TX Retirement Fac Rev
Wesleyan Homes Inc. Proj...................................... 5.00% 01/01/24 298,291
500,000 New Hope Cultural Ed Facs Fin Corp TX Student Hsg Rev Chf
Collegiate Hsg Galveston I LLC TX A&M Univ Galveston.......... 5.00% 04/01/22 546,605
25,000 New Hope Cultural Ed Facs Fin Corp TX Student Hsg Rev Chf
Stephenville-Tarleton St Univ Proj, Ser A..................... 4.25% 04/01/22 26,584
480,000 Red River TX Hlth Facs Dev Corp Retirement Fac Rev MRC
Crestview, Ser A.............................................. 7.75% 11/15/31 558,557
600,000 TX St Muni Gas Acquisition & Supply Corp III Gas Supply Rev...... 5.00% 12/15/24 688,338
------------
3,542,890
------------
UTAH - 1.6%
500,000 UT St Chrt Sch Fin Auth Chrt Sch Rev Spectrum Academy
Proj (e)...................................................... 6.00% 04/15/45 520,710
------------
VIRGIN ISLANDS - 0.3%
100,000 Virgin Islands Wtr & Pwr Auth Elec Sys Rev Ref, Ser A............ 4.00% 07/01/21 106,077
------------
WASHINGTON - 1.4%
155,000 Mason Cnty WA Pub Utility Dist #1 Sys............................ 3.50% 12/01/21 157,375
110,000 Skagit Cnty WA Pub Hosp Dist #1 Ref & Impt, Ser A................ 5.00% 12/01/22 123,853
165,000 Skagit Cnty WA Pub Hosp Dist #1 Skagit Valley Hosp............... 5.00% 12/01/20 182,883
------------
464,111
------------
WEST VIRGINIA - 2.2%
630,000 Monongalia Cnty WV Bldg Commission Rev Ref Monogalia
Hlth Sys Group................................................ 5.00% 07/01/25 740,729
------------
WISCONSIN - 4.2%
500,000 WI St Hlth & Edl Facs Auth Rev Ref Marquette Univ................ 5.00% 10/01/28 572,025
735,000 WI St Hlth & Edl Facs Auth Rev Ref Prohealth Care Oblig
Group......................................................... 5.00% 08/15/31 825,368
------------
1,397,393
------------
TOTAL INVESTMENTS - 95.1%................................................................... 31,889,476
(Cost $31,402,987) (f)
NET OTHER ASSETS AND LIABILITIES - 4.9%..................................................... 1,639,764
------------
NET ASSETS - 100.0%......................................................................... $ 33,529,240
============
See Notes to Financial Statements Page 11
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
(a) Pursuant to procedures adopted by the Trust's Board of Trustees, this
security has been determined to be illiquid by First Trust Advisors L.P.
("First Trust"), the Fund's advisor.
(b) Zero coupon bond.
(c) The following table provides a listing of those entities that have either
issued, guaranteed, backed or otherwise enhanced the credit quality of
more than 5% of the net assets of the Fund. In instances where the entity
has guaranteed, backed or otherwise enhanced the credit quality of a
security, it is not primarily responsible for the issuer's obligations but
may be called upon to satisfy the issuer's obligations.
Entity Percentage
-----------------------------------------------------
Assured Guaranty Municipal Corp. 6.8%
(d) Security has a mandatory put by the holder. Maturity date reflects such
put.
(e) 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, and may be resold in transactions exempt from
registration, normally to qualified institutional buyers. Pursuant to
procedures adopted by the Trust's Board of Trustees, this security has
been determined to be liquid by First Trust. 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 October 31, 2015,
securities noted as such amounted to $520,710, or 1.6% of net assets.
(f) Aggregate cost for federal income tax purposes is $31,397,468. As of
October 31, 2015, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was
$538,299 and the aggregate gross unrealized depreciation for all
securities in which there was an excess of tax cost over value was
$46,291.
AGM Assured Guaranty Municipal Corp.
AMT Alternative Minimum Tax
BAM Building America Mutual
CA MTG INS California Mortgage Insurance
COP Certificates of Participation
GAN Grant Anticipation Notes
NATL-RE National Public Finance Guarantee Corp.
-----------------------------
VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of October 31,
2015 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
INVESTMENTS 10/31/2015 PRICES INPUTS INPUTS
--------------------------------------------------- ------------- ------------- -------------- --------------
Municipal Bonds*................................... $ 31,889,476 $ -- $ 31,889,476 $ --
============= ============= ============== ==============
* See Portfolio of Investments for state 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 October 31, 2015.
Page 12 See Notes to Financial Statements
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 2015
ASSETS:
Investments, at value.................................................. $ 31,889,476
Cash................................................................... 3,242,787
Receivables:
Investment securities sold.......................................... 1,035,304
Interest............................................................ 342,802
Miscellaneous....................................................... 5,750
-----------------
Total Assets........................................................ 36,516,119
-----------------
LIABILITIES:
Payables:
Investment securities purchased..................................... 2,969,691
Investment advisory fees............................................ 17,188
-----------------
Total Liabilities................................................... 2,986,879
-----------------
NET ASSETS............................................................. $ 33,529,240
=================
NET ASSETS CONSIST OF:
Paid-in capital........................................................ $ 32,858,528
Par value.............................................................. 6,500
Accumulated net investment income (loss)............................... 5,519
Accumulated net realized gain (loss) on investments.................... 172,204
Net unrealized appreciation (depreciation) on investments.............. 486,489
-----------------
NET ASSETS............................................................. $ 33,529,240
=================
NET ASSET VALUE, per share............................................. $ 51.58
=================
Number of shares outstanding (unlimited number of shares
authorized, par value $0.01 per share).............................. 650,002
=================
Investments, at cost................................................... $ 31,402,987
=================
See Notes to Financial Statements Page 13
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED OCTOBER 31, 2015
INVESTMENT INCOME:
Interest............................................................... $ 781,968
-----------------
Total investment income............................................. 781,968
-----------------
EXPENSES:
Investment advisory fees............................................... 155,117
-----------------
Total expenses...................................................... 155,117
-----------------
NET INVESTMENT INCOME (LOSS)........................................... 626,851
-----------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on investments............................. 179,530
Net change in unrealized appreciation (depreciation) on investments. 32,171
-----------------
NET REALIZED AND UNREALIZED GAIN (LOSS)................................ 211,701
-----------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING
FROM OPERATIONS..................................................... $ 838,552
=================
Page 14 See Notes to Financial Statements
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEAR ENDED OCTOBER 31, 2015
FOR THE FOR THE PERIOD
YEAR 5/13/2014 (a)
ENDED THROUGH
10/31/2015 10/31/2014
----------------- -----------------
OPERATIONS:
Net investment income (loss)........................................... $ 626,851 $ 225,551
Net realized gain (loss)............................................... 179,530 2,805
Net change in unrealized appreciation (depreciation)................... 32,171 454,318
----------------- -----------------
Net increase (decrease) in net assets resulting from operations........ 838,552 682,674
----------------- -----------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income.................................................. (638,253) (218,761)
Return of capital...................................................... -- (39,240)
----------------- -----------------
Total distributions to shareholders.................................... (638,253) (258,001)
----------------- -----------------
SHAREHOLDER TRANSACTIONS:
Proceeds from shares sold.............................................. 15,444,063 20,020,100
Cost of shares redeemed................................................ (2,559,895) --
----------------- -----------------
Net increase (decrease) in net assets resulting from
shareholder transactions............................................ 12,884,168 20,020,100
----------------- -----------------
Total increase (decrease) in net assets................................ 13,084,467 20,444,773
NET ASSETS:
Beginning of period.................................................... 20,444,773 --
----------------- -----------------
End of period.......................................................... $ 33,529,240 $ 20,444,773
================= =================
Accumulated net investment income (loss) at end of period.............. $ 5,519 $ 9,595
================= =================
CHANGES IN SHARES OUTSTANDING:
Shares outstanding, beginning of period................................ 400,002 --
Shares sold............................................................ 300,000 400,002
Shares redeemed........................................................ (50,000) --
----------------- -----------------
Shares outstanding, end of period...................................... 650,002 400,002
================= =================
(a) Inception date is May 13, 2014, which is consistent with the commencement
of investment operations and is the date the initial creation units were
established.
See Notes to Financial Statements Page 15
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FOR THE PERIOD
YEAR 5/13/2014 (a)
ENDED THROUGH
10/31/2015 10/31/2014
-------------- --------------
Net asset value, beginning of period $ 51.11 $ 50.00
---------- ----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) 1.35 0.56
Net realized and unrealized gain (loss) 0.50 1.20
---------- ----------
Total from investment operations 1.85 1.76
---------- ----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income (1.38) (0.55)
Return of capital -- (0.10)
---------- ----------
Total distributions (1.38) (0.65)
---------- ----------
Net asset value, end of period $ 51.58 $ 51.11
========== ==========
TOTAL RETURN (b) 3.66% 3.53%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 33,529 $ 20,445
Ratio of total expenses to average net assets 0.65% 0.65% (c)
Ratio of net investment income (loss) to
average net assets 2.63% 2.40% (c)
Portfolio turnover rate (d) 109% 69%
(a) Inception date is consistent with the commencement of investment
operations and is the date the initial creation units were established.
(b) Total return is calculated assuming an initial investment made at the net
asset value at the beginning of the period, reinvestment of all
distributions at net asset value during the period, and redemption at net
asset value on the last day of the period. The returns presented do not
reflect the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption or sale of Fund shares. Total return is
calculated for the time period presented and is not annualized for periods
of less than a year.
(c) Annualized.
(d) Portfolio turnover is calculated for the time period presented and is not
annualized for periods of less than a year and does not include securities
received or delivered from processing creations or redemptions and in-kind
transactions.
Page 16 See Notes to Financial Statements
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015
1. ORGANIZATION
First Trust Exchange-Traded Fund III (the "Trust") is a non-diversified open-end
management investment company organized as a Massachusetts business trust on
January 9, 2008, and is registered with the Securities and Exchange Commission
under the Investment Company Act of 1940, as amended (the "1940 Act").
The Trust consists of four funds that are currently offering shares. This report
covers the First Trust Managed Municipal ETF (the "Fund"), which trades under
the ticker FMB on The NASDAQ(R) Stock Market, LLC ("NASDAQ"). Unlike
conventional mutual funds, the Fund issues and redeems shares on a continuous
basis, at net asset value ("NAV"), only in large specified blocks consisting of
50,000 shares called a "Creation Unit." Creation Units are issued and redeemed
for securities in which the Fund invests or for cash or, in certain
circumstances, a combination of both. Except when aggregated in Creation Units,
the Fund's shares are not redeemable securities.
The primary investment objective of the Fund is to generate current income that
is exempt from regular federal income taxes and its secondary objective is
long-term capital appreciation. Under normal market conditions, the Fund seeks
to achieve its investment objectives by investing at least 80% of its net assets
(including investment borrowings) in municipal debt securities that pay interest
that is exempt from regular federal income taxes. 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 Fund, which is an investment company within the scope of Financial
Accounting Standards Board ("FASB") Accounting Standards Update 2013-08, follows
accounting and reporting guidance under FASB Accounting Standards Codification
Topic 946, "Financial Services-Investment Companies." The following is a summary
of significant accounting policies consistently followed by the Fund in the
preparation of the financial statements. The preparation of the 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 Fund's NAV is determined daily as of the close of regular trading on the New
York Stock Exchange ("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 are priced using data
reflecting the earlier closing of the principal markets for those securities.
The Fund's NAV is calculated by dividing the value of all assets of the Fund
(including accrued interest and dividends), less all liabilities (including
accrued expenses and dividends declared but unpaid), by the total number of
shares outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value. Market
value prices represent last sale or official closing prices from a national or
foreign exchange (i.e., a regulated market) and are primarily obtained from
third-party pricing services. Fair value prices represent any prices not
considered market value prices and are either obtained from a third-party
pricing service or are determined by the Pricing Committee of the Fund's
investment advisor, First Trust Advisors L.P. ("First Trust" or the "Advisor"),
in accordance with valuation procedures adopted by the Trust's Board of
Trustees, and in accordance with provisions of the 1940 Act. Investments valued
by the Advisor's Pricing Committee, if any, are footnoted as such in the
footnotes to the Portfolio of Investments. The Fund's investments are valued as
follows:
Municipal securities and other debt securities are fair valued on the
basis of fair valuations provided by dealers who make markets in such
securities or by an independent pricing service approved by the Trust'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.
Fixed income and other debt securities having a remaining maturity of 60
days or less when purchased are fair valued at cost adjusted for
amortization of premiums and accretion of discounts (amortized cost),
provided the Advisor's Pricing Committee has determined that the use of
amortized cost is an appropriate reflection of fair value given market and
issuer-specific conditions existing at the time of the determination.
Factors that may be considered in determining the appropriateness of the
use of amortized cost include, but are not limited to, the following:
Page 17
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015
1) the credit conditions in the relevant market and changes thereto;
2) the liquidity conditions in the relevant market and changes thereto;
3) the interest rate conditions in the relevant market and changes
thereto (such as significant changes in interest rates);
4) issuer-specific conditions (such as significant credit
deterioration); and
5) any other market-based data the Advisor's Pricing Committee
considers relevant. In this regard, the Advisor's Pricing Committee
may use last-obtained market-based data to assist it when valuing
portfolio securities using amortized cost.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Trust's Board of Trustees or its
delegate, the Advisor's Pricing Committee, at fair value. These securities
generally include, but are not limited to, restricted securities (securities
which may not be publicly sold without registration under the Securities Act of
1933, as amended) for which a pricing service is unable to provide a market
price; securities whose trading has been formally suspended; a security whose
market or fair value price is not available from a pre-established pricing
source; a security with respect to which an event has occurred that is likely to
materially affect the value of the security after the market has closed but
before the calculation of the Fund's NAV or make it difficult or impossible to
obtain a reliable market quotation; and a security whose price, as provided by
the pricing service, does not reflect the security's fair value. As a general
principle, the current fair value of a security would appear to be the amount
which the owner might reasonably expect to receive for the security upon its
current sale. When fair value prices are used, generally they will differ from
market quotations or official closing prices on the applicable exchanges. A
variety of factors may be considered in determining the fair value of such
securities, 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 security;
4) the financial statements of the issuer;
5) the credit quality and cash flow of the issuer, based on the
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; and
10) other relevant factors.
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 methodologies 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 October 31, 2015, is
included with the Fund's Portfolio of Investments.
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.
Page 18
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015
C. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income, if any, are declared and paid monthly, or
as the Board of Trustees may determine from time to time. Distributions of net
realized capital gains earned by the Fund, if any, will be distributed at least
annually.
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 net asset value
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 time in the future.
The tax character of distributions paid during the fiscal year ended October 31,
2015 and the fiscal period ended October 31, 2014 was as follows:
Distributions paid from: 2015 2014
Ordinary income.................................... $ 25,837 $ 8,427
Tax-exempt income.................................. 612,416 210,334
Return of capital.................................. -- 39,240
As of October 31, 2015, the components of distributable earnings on a tax basis
were as follows:
Undistributed ordinary income...................... $ 5,519
Accumulated capital and other losses............... 172,204
Net unrealized appreciation (depreciation)......... 486,489
D. 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 (the "Internal Revenue Code"), 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 and 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.
In addition, the Fund intends to invest in municipal securities that allow it to
pay shareholders "exempt dividends" as defined in the Internal Revenue Code.
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. The taxable years ended 2014 and
2015 remain open to federal and state audit. As of October 31, 2015, 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.
The Fund intends to utilize provisions of the federal income tax laws, which
allow it to carry a realized capital loss forward indefinitely following the
year of the loss and offset such loss against any future realized capital gains.
The Fund is subject to certain limitations under U.S. tax rules on the use of
capital carryforwards and net unrealized built-in losses. These limitations
apply when there has been a 50% change in ownership. At October 31, 2015, the
Fund had no non-expiring capital loss carryforwards for federal income tax
purposes.
Certain losses realized during the current fiscal year may be deferred and
treated as occurring on the first day of the following fiscal year for federal
income tax purposes. For the fiscal year ended October 31, 2015, the Fund had no
net ordinary losses.
In order to present paid-in capital, accumulated net investment income (loss)
and accumulated net realized gain (loss) on investments on the Statement of
Assets and Liabilities that more closely represent their tax character, certain
adjustments have been made to paid-in capital, accumulated net investment income
(loss) and accumulated net realized gain (loss) on investments. These
adjustments are primarily due to the difference between book and tax treatments
of income and gains on various investment securities held by the Fund and
in-kind transactions. The results of operations and net assets were not affected
by these adjustments. For the fiscal year ended October 31, 2015, the
adjustments for the Fund were as follows:
Accumulated
Accumulated Net Realized
Net Investment Gain (Loss) Paid-in
Income (Loss) on Investments Capital
--------------- --------------- -------------
$ 7,326 $ (7,326) $ --
Page 19
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015
E. EXPENSES
Expenses, other than the investment advisory fee and other excluded expenses,
are paid by the Advisor (see Note 3).
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 selection and ongoing monitoring of the securities
in the Fund's portfolio, managing the Fund's business affairs and providing
certain administrative services necessary for the management of the Fund.
Pursuant to the Investment Management Agreement between the Trust and the
Advisor, First Trust manages the investment of the Fund's assets and is
responsible for the Fund's expenses, including the cost of transfer agency,
custody, fund administration, legal, audit and other services, but excluding fee
payments under the Investment Management Agreement, interest, taxes, brokerage
commissions and other expenses connected with the execution of portfolio
transactions, distribution and service fees pursuant to a 12b-1 plan, if any,
and extraordinary expenses. The Fund has agreed to pay First Trust an annual
unitary management fee equal to 0.65% of its average daily net assets. First
Trust also provides fund reporting services to the Fund for a flat annual fee in
the amount of $9,250, which is covered under the annual unitary management fee.
The Trust has multiple service agreements with Brown Brothers Harriman & Co.
("BBH"). Under the service agreements, BBH performs custodial, fund accounting,
certain administrative services, and transfer agency services for the Fund. As
custodian, BBH is responsible for custody of the Fund's assets. As fund
accountant and administrator, BBH is responsible for maintaining the books and
records of the Fund's securities and cash. As transfer agent, BBH is responsible
for maintaining shareholder records for the Fund.
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 that is allocated pro rata among each fund in the First Trust Fund
Complex based on net assets. Each Independent Trustee is also paid an annual per
fund fee that varies based on whether the fund is a closed-end or other actively
managed fund, or is an index fund.
Additionally, the Lead Independent Trustee and the Chairmen of the Audit
Committee, Nominating and Governance Committee and Valuation Committee are paid
annual fees 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 Committee Chairmen rotate every
three years. The officers and "Interested" Trustee receive no compensation from
the Trust for acting in such capacities.
4. PURCHASES AND SALES OF SECURITIES
For the year ended October 31, 2015, the cost of purchases and proceeds from
sales of investments, excluding short-term investments and in-kind transactions,
were $37,149,229 and $24,798,365, respectively.
For the year ended October 31, 2015, the Fund had no in-kind transactions.
5. BORROWINGS
Effective March 26, 2015, the Fund was added to an $80 million Credit Agreement
with The Bank of Nova Scotia ("Scotia") as administrative agent for a group of
lenders. The Credit Agreement is to be used as a liquidity backstop during
periods of high redemption volume. A commitment fee of 0.15% of the daily amount
of the excess of the commitment amount over the outstanding principal balance of
the loans is charged by Scotia, which First Trust allocates amongst the funds
that have access to the credit line. To the extent that the Fund accesses the
credit line, there would also be an interest fee charged. The Fund did not have
any borrowings outstanding during the year ended October 31, 2015.
6. CREATIONS, REDEMPTIONS AND TRANSACTION FEES
Shares are created and redeemed by the Fund only in Creation Unit size
aggregations of 50,000 shares in transactions with broker-dealers or large
institutional investors that have entered into a participation agreement (an
"Authorized Participant"). In order to purchase Creation Units of the Fund, an
Authorized Participant must deposit (i) a designated portfolio of securities and
other instruments determined by First Trust (the "Deposit Securities") and
generally make or receive a cash payment referred to as the "Cash Component,"
which is an amount equal to the difference between the NAV of the Fund Shares
(per Creation Unit Aggregation) and the market value of the Deposit Securities,
and/or (ii) cash in lieu of all or a portion of the Deposit Securities. If the
Cash Component is a positive number (i.e., the NAV per Creation Unit Aggregation
Page 20
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015
exceeds the Deposit Amount), the Authorized Participant will deliver the Cash
Component. If the Cash Component is a negative number (i.e., the NAV per
Creation Unit Aggregation is less than the Deposit Amount), the Authorized
Participant will receive the Cash Component. Purchasers of Creation Units must
pay to BBH, as transfer agent, a creation fee (the "Creation Transaction Fee")
regardless of the number of Creation Units purchased in the transaction. The
Creation Transaction Fee may vary and is based on the composition of the
securities included in the Fund's portfolio and the countries in which the
transactions are settled. The Creation Transaction Fee is currently $500. The
price for each Creation Unit will equal the daily NAV per share times the number
of shares in a Creation Unit plus the fees described above and, if applicable,
any operational processing and brokerage costs, transfer fees or stamp taxes.
When the Fund permits an Authorized Participant to substitute cash or a
different security in lieu of depositing one or more of the requisite Deposit
Securities, the Authorized Participant may also be assessed an amount to cover
the cost of purchasing the Deposit Securities and/or disposing of the
substituted securities, including operational processing and brokerage costs,
transfer fees, stamp taxes, and part or all of the spread between the expected
bid and offer side of the market related to such Deposit Securities and/or
substitute securities.
Authorized Participants redeeming Creation Units must pay to BBH, as transfer
agent, a redemption transaction fee (the "Redemption Transaction Fee"),
regardless of the number of Creation Units redeemed in the transaction. The
Redemption Transaction Fee may vary and is based on the composition of the
securities included in the Fund's portfolio and the countries in which the
transactions are settled. The Redemption Transaction Fee is currently $500. The
Fund reserves the right to effect redemptions in cash. An Authorized Participant
may request cash redemption in lieu of securities; however, the Fund may, in its
discretion, reject any such request.
7. DISTRIBUTION PLAN
The Board of Trustees adopted a Distribution and Service Plan pursuant to Rule
12b-1 under the 1940 Act. In accordance with the Rule 12b-1 plan, the Fund is
authorized to pay an amount up to 0.25% of its average daily net assets each
year to reimburse First Trust Portfolios L.P. ("FTP"), the distributor of the
Fund, for amounts expended to finance activities primarily intended to result in
the sale of Creation Units or the provision of investor services. FTP may also
use this amount to compensate securities dealers or other persons that are
Authorized Participants for providing distribution assistance, including
broker-dealer and shareholder support and educational and promotional services.
No 12b-1 fees are currently paid by the Fund, and pursuant to a contractual
arrangement, no 12b-1 fees will be paid any time before May 15, 2016.
8. INDEMNIFICATION
The Trust, on behalf of the Fund, has a variety of indemnification obligations
under contracts with its service providers. The Trust's maximum exposure under
these arrangements is unknown. However, the Trust has not had prior claims or
losses pursuant to these contracts and expects the risk of loss to be remote.
9. ADOPTION OF NON-FUNDAMENTAL INVESTMENT POLICY
On March 27, 2015, the Board of Trustees of the Trust approved the adoption of a
non-fundamental investment policy regarding the Fund's ability to invest in
other investment companies (the "Policy"). Pursuant to the Policy, beginning
June 7, 2015, the Fund no longer relies on Section 12(d)(1)(F) or 12(d)(1)(G) of
the 1940 Act to invest in other investment companies.
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 November 19, 2015, the Fund declared a distribution of $0.115 per share to
shareholders of record on November 24, 2015, payable November 30, 2015.
At a meeting on December 7, 2015, the Board accepted Mr. Bradley's resignation
from his position as the President and Chief Executive Officer of the Trust,
effective December 31, 2015. At the same meeting, the Board elected Mr. Dykas to
serve as the President and Chief Executive Officer and Mr. Donald Swade,
formerly an Assistant Treasurer of the Trust, to serve as the Treasurer, Chief
Financial Officer and Chief Accounting Officer of the Trust.
Page 21
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------------------------------
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST MANAGED MUNICIPAL ETF:
We have audited the accompanying statement of assets and liabilities of First
Trust Managed Municipal ETF (the "Fund"), a series of the First Trust
Exchange-Traded Fund III, including the portfolio of investments, as of October
31, 2015, and the related statement of operations for the year then ended, and
the statements of changes in net assets and the financial highlights for each of
the periods presented. These financial statements and financial highlights are
the responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of October 31, 2015 by correspondence with the Fund's
custodian and brokers; when replies were not received from brokers, we performed
other auditing procedures. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of First
Trust Managed Municipal ETF as of October 31, 2015, the results of its
operations for the year then ended, and the changes in its net assets and the
financial highlights for each of the periods presented, in conformity with
accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Chicago, Illinois
December 23, 2015
Page 22
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015 (UNAUDITED)
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Trust 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.
PORTFOLIO HOLDINGS
The Trust 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 Trust's Form N-Qs
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.
FEDERAL TAX INFORMATION
For the taxable year ended October 31, 2015, the following distribution
information is being provided as required by the Internal Revenue Code or to
meet a specific state's requirement. The Fund designates the following amounts
or, if subsequently determined to be different, the maximum amount allowable for
its fiscal year ended October 31, 2015:
Federal and State Income Tax Percentages
------------------------------- -------------------------
Tax-Exempt Interest Dividends 99.98%
Alternative minimum tax (AMT) 11.62%
RISK CONSIDERATIONS
You could lose money by investing in the Fund. An investment in the Fund is not
a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other governmental agency. There can be no
assurance that the Fund's investment objectives will be achieved.
ALTERNATIVE MINIMUM TAX RISK. The Fund has no limit as to the amount that can be
invested in alternative minimum tax bonds. Therefore, all or a portion of the
Fund's otherwise exempt-interest dividends may be taxable to those shareholders
subject to the federal alternative minimum tax.
CALL RISK. If an issuer calls higher-yielding debt instruments held by the Fund,
performance could be adversely impacted.
CASH TRANSACTIONS RISK. The Fund will, under most circumstances, effect a
portion of creations and redemptions for cash, rather than in-kind securities.
As a result, an investment in the Fund may be less tax-efficient than an
investment in an exchange-traded fund that effects its creations and redemption
for in-kind securities. Because the Fund may effect a portion of redemptions for
cash, it may be required to sell portfolio securities in order to obtain the
cash needed to distribute redemption proceeds. A sale of shares may result in
capital gains or losses and may also result in higher brokerage costs.
CREDIT RISK. Credit risk is the risk that an issuer of a security will be unable
or unwilling to make dividend, interest and/or principal payments when due and
the related risk that the value of a security may decline because of concerns
about the issuer's ability to make such payments.
HIGH YIELD SECURITIES RISK. High yield securities, or "junk" bonds, are subject
to greater market fluctuations and risk of loss than securities with higher
ratings, and therefore, are considered to be highly speculative. These
securities are issued by issuers that may have narrowly focused operations
and/or other impediments to the timely payment of periodic interest and
principal at maturity. If the economy slows down or dips into recession, the
issuers of high yield securities may not have sufficient resources to continue
making timely payment of periodic interest and principal at maturity. The market
for high yield securities is smaller and less liquid than that for investment
grade securities. High yield securities are generally not listed on a national
securities exchange but trade in the over-the-counter markets. Due to the
smaller, less liquid market for high yield securities, the bid-offer spread on
such securities is generally greater than it is for investment grade securities
and the purchase or sale of such securities may take longer to complete. In
general, high yield securities may have a greater risk of default than other
types of securities.
INCOME RISK. Income from the Fund's fixed income investments could decline
during periods of falling interest rates.
Page 23
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015 (UNAUDITED)
INTEREST RATE RISK. Interest rate risk is the risk that the value of the
securities in the Fund will decline because of rising market interest rates.
When interest rates change, the values of longer duration debt securities
usually change more than the values of shorter duration debt securities.
MANAGEMENT RISK. The Fund is subject to management risk because it is an
actively managed portfolio. In managing the Fund's investment portfolio, the
advisor will apply investment techniques and risk analyses that may not have the
desired result. There can be no guarantee that the Fund will meet its investment
objectives.
MARKET RISK. Market risk is the risk that a particular security owned by the
Fund or shares of the Fund in general may fall in value. Securities are subject
to market fluctuations caused by such factors as economic, political, regulatory
or market developments, changes in interest rates and perceived trends in bond
prices. Also, certain of these factors may affect the liquidity of the bonds in
the Fund's portfolio and make it more difficult for the Fund to sell them.
Overall security values could decline generally or could underperform other
investments.
MUNICIPAL LEASE OBLIGATIONS RISK. Participation interests in municipal leases
pose special risks because many leases and contracts contain "non-appropriation"
clauses that provide that the governmental issuer has no obligation to make
future payments under the lease or contract unless money is appropriated for
this purpose by the appropriate legislative body.
NEW FUND RISK. The Fund currently has fewer assets than larger funds, and like
other relatively new funds, large inflows and outflows may impact the Fund's
market exposure for limited periods of time. This impact may be positive or
negative, depending on the direction of market movement during the period
affected.
NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the
Investment Company Act of 1940 Act (the "1940 Act"). As a result, the Fund is
only limited as to the percentage of its assets that may be invested in the
securities of any one issuer by the diversification requirements imposed by the
Internal Revenue Code of 1986, as amended (the "Code"). The Fund may invest a
relatively high percentage of its assets in a limited number of issuers. As a
result, the Fund may be more susceptible to a single adverse economic or
regulatory occurrence affecting one or more of these issuers, experience
increased volatility and be highly concentrated in certain issuers.
POLITICAL AND ECONOMIC RISKS. The values of Municipal Securities held by the
Fund may be adversely affected by local political and economic conditions and
developments. Adverse conditions in an industry significant to a local economy
could have a correspondingly adverse effect on the financial condition of local
issuers.
TAX RISK. Interest income from Municipal Securities is normally not subject to
regular federal income tax, but income from Municipal Securities held by the
Fund could be declared taxable because of, among other things, unfavorable
changes in tax laws, adverse interpretations by the Internal Revenue Service or
state tax authorities or noncompliant conduct of a bond issuer. Consequently,
the attractiveness of Municipal Securities in relation to other investment
alternatives is affected by changes in federal income tax rates or changes in
the tax-exempt status of interest income from Municipal Securities.
ZERO COUPON BONDS RISK. Zero coupon bonds do not pay interest on a current basis
and may be highly volatile as interest rates rise or fall. In addition, while
such bonds generate income for purposes of generally accepted accounting
standards, they do not generate cash flow and thus could cause the Fund to be
forced to liquidate securities at an inopportune time in order to distribute
cash, as required by tax laws.
INVESTMENT MANAGEMENT AGREEMENT
BOARD CONSIDERATIONS REGARDING CONTINUATION OF INVESTMENT MANAGEMENT AGREEMENT
The Board of Trustees of the First Trust Exchange-Traded Fund III (the "Trust"),
including the Independent Trustees, unanimously approved the continuation of the
Investment Management Agreement (the "Agreement") with First Trust Advisors L.P.
(the "Advisor" or "First Trust") on behalf of First Trust Managed Municipal ETF
(the "Fund"). The Board approved the continuation of the Agreement for a
one-year period ending June 30, 2016, at a meeting held on June 16, 2015. The
Board determined that the continuation of the Agreement is in the best interests
of the Fund in light of the extent and quality of services provided and such
other matters as the Board considered to be relevant in the exercise of its
reasonable business judgment.
To reach this determination, the Board considered its duties under the
Investment Company Act of 1940, as amended (the "1940 Act"), as well as under
the general principles of state law in reviewing and approving advisory
contracts; the requirements of the 1940 Act in such matters; the fiduciary duty
of investment advisors with respect to advisory agreements and compensation; the
standards used by courts in determining whether investment company boards have
fulfilled their duties; and the factors to be considered by the Board in voting
on such agreements. At meetings held on April 20, 2015 and June 16, 2015, the
Page 24
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015 (UNAUDITED)
Board, including the Independent Trustees, reviewed materials provided by the
Advisor and others responding to requests for information from counsel to the
Independent Trustees that, among other things, outlined the services provided by
the Advisor (including the relevant personnel responsible for these services and
their experience); the unitary fee for the Fund as compared to fees charged to a
peer group of funds for the Fund (most of which were exchange-traded funds or
"ETFs") compiled by Management Practice, Inc. ("MPI"), an independent source
(the "MPI Peer Group"), and as compared to fees charged to other clients of the
Advisor with similar investment objectives and to other ETFs managed by the
Advisor; expenses of the Fund compared to expense ratios of the funds in the MPI
Peer Group; performance information for the Fund; the nature of expenses
incurred in providing services to the Fund and the potential for economies of
scale, if any; financial data on the Advisor; any fall-out benefits to the
Advisor and its affiliate, First Trust Portfolios L.P. ("FTP"); and a summary of
the Advisor's compliance program. The Board reviewed initial materials with the
Advisor at a special meeting held on April 20, 2015, at which the Independent
Trustees and their counsel met separately to discuss the information provided by
the Advisor. Following the April meeting, independent legal counsel on behalf of
the Independent Trustees requested certain clarifications and supplements to the
materials provided, and those were considered at an executive session of the
Independent Trustees and independent legal counsel held prior to the June 16,
2015 meeting, as well as at the meeting. The Board applied its business judgment
to determine whether the arrangement between the Trust and the Advisor is a
reasonable business arrangement from the Fund's perspective as well as from the
perspective of shareholders. The Board considered that shareholders chose to
invest or remain invested in the Fund knowing that the Advisor manages the Fund
and knowing the Fund's unitary fee.
In reviewing the Agreement, the Board considered the nature, extent and quality
of services provided by the Advisor under the Agreement. The Board considered
that, unlike most other ETFs to which First Trust currently provides management
services, the Fund is not designed to track the performance of an index. The
Board considered that the Advisor is responsible for the overall management and
administration of the Trust and the Fund and reviewed the services provided by
the Advisor to the Fund. The Board noted the compliance program that had been
developed by the Advisor. The Board considered the significant asset growth of
the First Trust Fund Complex (particularly in ETFs) and the Advisor's
concomitant investment in infrastructure and personnel dedicated to the First
Trust funds. In light of the information presented and the considerations made,
the Board concluded that the nature, extent and quality of services provided to
the Trust and the Fund by the Advisor under the Agreement have been and are
expected to remain satisfactory and that the Advisor has managed the Fund
consistent with the Fund's investment objectives and policies.
The Board considered the unitary fee payable by the Fund under the Agreement,
noting that the Fund pays the Advisor a fee equal to an annual rate of 0.65% of
its average daily net assets. The Board noted that the Advisor is responsible
for the Fund's expenses, including the cost of transfer agency, custody, fund
administration, legal, audit and other services, but excluding interest, taxes,
brokerage commissions and other expenses connected with the execution of
portfolio transactions, distribution and service fees pursuant to a Rule 12b-1
plan, if any, and extraordinary expenses. The Board also reviewed data prepared
by MPI showing the unitary fee for the Fund as compared to the advisory fees and
expense ratios of the peer funds in the MPI Peer Group and determined that,
because the Fund charges a unitary fee, expense ratios were the most relevant
data point. Based on the information provided, the Board noted that the unitary
fee for the Fund was above the median total (net) expense ratio of the peer
funds in the MPI Peer Group. The Independent Trustees discussed with
representatives of the Advisor and independent counsel limitations in creating
peer groups for actively-managed ETFs and different business models that affect
the pricing of services among ETF sponsors. The Board noted that most of the
funds in the MPI Peer Group were significantly larger than the Fund and most of
the peer funds were not actively managed. The Board took these limitations and
differences into account in considering the MPI data. The Board also compared
the Fund's unitary fee to the total expense ratios (after fee waivers and/or
expense reimbursements, if any) of other First Trust ETFs, including First Trust
ETFs that pay a unitary fee.
The Board considered performance information for the Fund, noting that the
performance information included the Fund's quarterly performance report, which
is part of the process that the Board has established for monitoring the Fund's
performance on an ongoing basis. The Board determined that this process
continues to be effective for reviewing the Fund's performance. The Board
reviewed data prepared by MPI comparing the Fund's performance to the MPI Peer
Group and to a broad-based benchmark index, and noted that the Fund outperformed
the MPI Peer Group average and the benchmark for the since-inception (May 13,
2014) period ended December 31, 2014.
On the basis of all the information provided on the unitary fee and performance
of the Fund, the Board concluded that the unitary fee for the Fund was
reasonable and appropriate in light of the nature, extent and quality of
services provided by the Advisor to the Fund under the Agreement.
The Board noted that the Advisor has made and continues to make significant
investments in personnel and infrastructure and considered whether the unitary
fee reflects any economies of scale for the benefit of shareholders. The Board
noted that any reduction in fixed costs associated with the management of the
Fund would benefit the Advisor but that the unitary fee structure provides a
level of certainty in expenses for the Fund. The Board also considered the costs
of the services provided and any profits realized by the Advisor from serving as
investment advisor to the Fund for the period ended December 31, 2014, as well
Page 25
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015 (UNAUDITED)
as product-line profitability data for the same period, as set forth in the
materials provided to the Board. The Board noted the inherent limitations in the
profitability analysis, and noted that the Fund was not profitable for the
Advisor. The Board considered that the Advisor had identified as a fall-out
benefit to the Advisor and FTP their exposure to investors and brokers who, in
the absence of the Fund, may have had no dealings with the Advisor or FTP. The
Board also considered the Advisor's compensation for fund reporting services
provided to the Fund pursuant to a separate Fund Reporting Services Agreement,
which is paid from the unitary fee.
Based on all of the information considered and the conclusions reached, the
Board, including the Independent Trustees, unanimously determined that the terms
of the Agreement continue to be fair and reasonable and that the continuation of
the Agreement is in the best interests of the Trust and the Fund. No single
factor was determinative in the Board's analysis.
Page 26
--------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015 (UNAUDITED)
The Trust's statement of additional information includes additional information
about the Trustees and is available, without charge, upon request, by calling
(800) 988-5891.
NUMBER OF OTHER
PORTFOLIOS IN TRUSTEESHIPS OR
TERM OF OFFICE THE FIRST TRUST DIRECTORSHIPS
NAME, ADDRESS, AND YEAR FIRST FUND COMPLEX HELD BY TRUSTEE
DATE OF BIRTH AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING PAST
POSITION WITH THE TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
------------------------------------------------------------------------------------------------------------------------------------
Richard E. Erickson, Trustee o Indefinite Term Physician; President, Wheaton Orthopedics; 117 None
c/o First Trust Advisors L.P. Limited Partner, Gundersen Real Estate
120 East Liberty Drive, o Since Inception Limited Partnership; Member, Sportsmed LLC
Suite 400
Wheaton, IL 60187
D.O.B.: 04/51
Thomas R. Kadlec, Trustee o Indefinite Term President (March 2010 to Present), Senior 117 Director of ADM
c/o First Trust Advisors L.P. Vice President and Chief Financial Officer Investor Services,
120 East Liberty Drive, o Since Inception (May 2007 to March 2010), ADM Investor Inc., ADM
Suite 400 Services, Inc. (Futures Commission Investor Services
Wheaton, IL 60187 Merchant) International and Futures Industry
D.O.B.: 11/57 Association
Robert F. Keith, Trustee o Indefinite Term President (2003 to Present), Hibs 117 Director of Trust
c/o First Trust Advisors L.P. Enterprises (Financial and Management Company of
120 East Liberty Drive, o Since Inception Consulting) Illinois
Suite 400
Wheaton, IL 60187
D.O.B.: 11/56
Niel B. Nielson, Trustee o Indefinite Term Managing Director and Chief Operating 117 Director of
c/o First Trust Advisors L.P. Officer (January 2015 to Present), Pelita Covenant
120 East Liberty Drive, o Since Inception Harapan Educational Foundation Transport, Inc.
Suite 400 (Educational Products and Services); (May 2003 to
Wheaton, IL 60187 President and Chief Executive Officer May 2014)
D.O.B.: 03/54 (June 2012 to September 2014), Servant
Interactive LLC (Educational Products and
Services); President and Chief Executive
Officer (June 2012 to September 2014), Dew
Learning LLC (Educational Products and
Services); President (June 2002 to June
2012), Covenant College
------------------------------------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
James A. Bowen(1), Trustee, o Indefinite Term Chief Executive Officer (December 2010 to 117 None
Chairman of the Board Present), President (until December 2010),
120 East Liberty Drive, o Since Inception First Trust Advisors L.P. and First Trust
Suite 400 Portfolios L.P.; Chairman of the Board of
Wheaton, IL 60187 Directors, BondWave LLC (Software
D.O.B.: 09/55 Development Company/Investment Advisor
and Stonebridge Advisors LLC (Investment
Advisor)
-----------------------------
(1) Mr. Bowen is deemed an "interested person" of the Trust due to his
position as Chief Executive Officer of First Trust Advisors L.P.,
investment advisor of the Trust.
Page 27
--------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015 (UNAUDITED)
POSITION AND TERM OF OFFICE
NAME, ADDRESS OFFICES AND LENGTH OF PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH TRUST SERVICE DURING PAST 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES(2)
------------------------------------------------------------------------------------------------------------------------------------
Mark R. Bradley President and Chief o Indefinite Term Chief Operating Officer (December 2010 to Present)
120 E. Liberty Drive, Executive Officer and Chief Financial Officer, First Trust Advisors
Suite 400 o Since Inception L.P. and First Trust Portfolios L.P.; Chief Financial
Wheaton, IL 60187 Officer, BondWave LLC (Software Development
D.O.B.: 11/57 Company/Investment Advisor) and Stonebridge
Advisors LLC (Investment Advisor)
James M. Dykas Treasurer, Chief Financial o Indefinite Term Controller (January 2011 to Present), Senior Vice
120 E. Liberty Drive, Officer and Chief President (April 2007 to Present), First Trust
Suite 400 Accounting Officer o Since Inception Advisors L.P. and First Trust Portfolios L.P.
Wheaton, IL 60187
D.O.B.: 01/66
W. Scott Jardine Secretary and Chief o Indefinite Term General Counsel, First Trust Advisors L.P., First
120 E. Liberty Drive, Legal Officer Trust Portfolios L.P.; Secretary and General Counsel,
Suite 400 o Since Inception BondWave LLC (Software Development Company/
Wheaton, IL 60187 Investment Advisor) and Secretary, Stonebridge
D.O.B.: 05/60 Advisors LLC (Investment Advisor)
Daniel J. Lindquist Vice President o Indefinite Term Managing Director (July 2012 to Present), Senior
120 E. Liberty Drive, Vice President (September 2005 to July 2012),
Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios
Wheaton, IL 60187 L.P.
D.O.B.: 02/70
Kristi A. Maher Chief Compliance Officer o Indefinite Term Deputy General Counsel, First Trust Advisors
120 E. Liberty Drive, and Assistant Secretary L.P. and First Trust Portfolios L.P.
Suite 400 o Since Inception
Wheaton, IL 60187
D.O.B.: 12/6
Roger F. Testin Vice President o Indefinite Term Senior Vice President, First Trust Advisors L.P.
120 E. Liberty Drive, and First Trust Portfolios L.P.
Suite 400 o Since Inception
Wheaton, IL 60187
D.O.B.: 06/66
Stan Ueland Vice President o Indefinite Term Senior Vice President (September 2012 to Present),
120 E. Liberty Drive, Vice President (August 2005 to September 2012),
Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios
Wheaton, IL 60187 L.P.
D.O.B.: 11/70
-----------------------------
(2) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 28
--------------------------------------------------------------------------------
PRIVACY POLICY
--------------------------------------------------------------------------------
FIRST TRUST MANAGED MUNICIPAL ETF (FMB)
OCTOBER 31, 2015 (UNAUDITED)
PRIVACY POLICY
First Trust values our relationship with you and considers your privacy an
important priority in maintaining that relationship. We are committed to
protecting the security and confidentiality of your personal information.
SOURCES OF INFORMATION
We collect nonpublic personal information about you from the following sources:
o Information we receive from you and your broker-dealer, investment
advisor or financial representative through interviews,
applications, agreements or other forms;
o Information about your transactions with us, our affiliates or
others;
o Information we receive from your inquiries by mail, e-mail or
telephone; and
o Information we collect on our website through the use of "cookies".
For example, we may identify the pages on our website that your
browser requests or visits.
INFORMATION COLLECTED
The type of data we collect may include your name, address, social security
number, age, financial status, assets, income, tax information, retirement and
estate plan information, transaction history, account balance, payment history,
investment objectives, marital status, family relationships and other personal
information.
DISCLOSURE OF INFORMATION
We do not disclose any nonpublic personal information about our customers or
former customers to anyone, except as permitted by law. In addition to using
this information to verify your identity (as required under law), the permitted
uses may also include the disclosure of such information to unaffiliated
companies for the following reasons:
o In order to provide you with products and services and to effect
transactions that you request or authorize, we may disclose your
personal information as described above to unaffiliated financial
service providers and other companies that perform administrative or
other services on our behalf, such as transfer agents, custodians
and trustees, or that assist us in the distribution of investor
materials such as trustees, banks, financial representatives, proxy
services, solicitors and printers.
o We may release information we have about you if you direct us to do
so, if we are compelled by law to do so, or in other legally limited
circumstances (for example to protect your account from fraud).
In addition, in order to alert you to our other financial products and services,
we may share your personal information within First Trust.
PRIVACY ONLINE
We allow third-party companies, including AddThis (a social media sharing
service), to collect certain anonymous information when you visit our website.
These companies may use non-personally identifiable information during your
visits to this and other websites in order to provide advertisements about goods
and services likely to be of greater interest to you. These companies typically
use a cookie, third party web beacon or pixel tags, to collect this information.
To learn more about this behavioral advertising practice, you can visit
www.networkadvertising.org.
CONFIDENTIALITY AND SECURITY
With regard to our internal security procedures, First Trust restricts access to
your nonpublic personal information to those First Trust employees who need to
know that information to provide products or services to you. We maintain
physical, electronic and procedural safeguards to protect your nonpublic
personal information.
POLICY UPDATES AND INQUIRIES
As required by federal law, we will notify you of our privacy policy annually.
We reserve the right to modify this policy at any time, however, if we do change
it, we will tell you promptly. For questions about our policy, or for additional
copies of this notice, please go to www.ftportfolios.com, or contact us at
1-800-621-1675 (First Trust Portfolios) or 1-800-222-6822 (First Trust
Advisors).
Page 29
This page intentionally left blank.
This page intentionally left blank.
This page intentionally left blank.
FIRST TRUST
First Trust Exchange-Traded Fund III
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
ADMINISTRATOR, CUSTODIAN,
FUND ACCOUNTANT &
TRANSFER AGENT
Brown Brothers Harriman & Co.
50 Post Office Square
Boston, MA 02110
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]
FIRST TRUST
First Trust Exchange-Traded Fund III
------------------------------------
First Trust Long/Short Equity ETF (FTLS)
Annual Report
For the Year Ended
October 31, 2015
--------------------------------------------------------------------------------
TABLE OF CONTENTS
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
ANNUAL REPORT
OCTOBER 31, 2015
Shareholder Letter......................................................... 1
Fund Performance Overview.................................................. 2
Portfolio Commentary....................................................... 5
Understanding Your Fund Expenses........................................... 7
Portfolio of Investments................................................... 8
Statement of Assets and Liabilities........................................ 17
Statement of Operations.................................................... 18
Statements of Changes in Net Assets........................................ 19
Financial Highlights....................................................... 20
Notes to Financial Statements.............................................. 21
Report of Independent Registered Public Accounting Firm.................... 26
Additional Information..................................................... 27
Board of Trustees and Officers............................................. 29
Privacy Policy............................................................. 31
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 its 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
the series of First Trust Exchange-Traded Fund III (the "Trust") described in
this report for the First Trust Long/Short Equity ETF (hereinafter referred to
as 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 its 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 objective. 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 investing in the Fund. See "Risk Considerations" in the Additional
Information section of this report 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 share price will fluctuate and Fund shares, when
sold, may be worth more or less than their original cost.
The Advisor may also periodically provide additional information on Fund
performance on the Fund's webpage at http://www.ftportfolios.com.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment in
the Fund. It includes details about the Fund's portfolio 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 the
Advisor 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 material risks of investing in the
Fund are spelled out in its prospectus, statement of additional information,
this report and other Fund regulatory filings.
--------------------------------------------------------------------------------
SHAREHOLDER LETTER
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
ANNUAL LETTER FROM THE CHAIRMAN AND CEO
OCTOBER 31, 2015
Dear Shareholders:
Thank you for your investment in First Trust Long/Short Equity ETF (the "Fund").
First Trust Advisors L.P. ("First Trust") is pleased to provide you with the
annual report which contains detailed information about your investment for the
12 months ended October 31, 2015, including a market overview and a performance
analysis for the period. We encourage you to read this report and discuss it
with your financial advisor.
U.S. markets, fueled by accelerating growth and an accommodating Federal
Reserve, enjoyed a prosperous year in 2014. However, most of 2015 has been
volatile. Economic and global factors, such as the continued conflict in the
Middle East, a sharp decline in oil prices and terrorism around the world, have
impacted U.S. and global markets. Another factor that has weighed upon U.S.
markets for most of the year is the fact that many economists had predicted that
the Federal Reserve would begin to raise interest rates in 2015, which has still
not happened.
As I have written previously, First Trust believes investors should maintain
perspective about the markets and have realistic expectations about their
investments. Markets will always go up and down, but we believe that having a
long-term investment horizon and being invested in quality products can help you
reach your goals.
Thank you for giving First Trust the opportunity to be a part of your investment
plan. We value the relationship and will continue to focus on our disciplined
investment approach and long-term perspective to help investors reach their
financial goals.
Sincerely,
/s/ James A. Bowen
James A. Bowen
Chairman of the Board of Trustees
Chief Executive Officer of First Trust Advisors L.P.
Page 1
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
The investment objective of First Trust Long/Short Equity ETF (the "Fund") is to
seek to provide investors with long-term total return. The Fund pursues its
objective by establishing long and short positions in a portfolio of Equity
Securities (as defined below). Under normal circumstances, at least 80% of the
Fund's net assets (plus the amount of any borrowing for investment purposes)
will be exposed to U.S. exchange-listed equity securities of U.S. and foreign
companies by investing in such securities directly and/or in U.S.
exchange-traded funds ("ETFs") that provide exposure to such securities. The
securities of the companies and ETFs in which the Fund will invest are referred
to collectively as "Equity Securities." The Equity Securities held by the Fund
may include U.S. exchange-listed equity securities of foreign issuers, as well
as investments in the equity securities of foreign issuers that are in the form
of depositary receipts.
The Fund takes long and short positions in Equity Securities. As opposed to
taking long positions in which an investor seeks to profit from increases in the
price of a security, short selling is a technique that will be used by the Fund
to try and profit from the falling price of a security. Short selling involves
selling a security that has been borrowed from a third party with the intention
of buying an identical security back at a later date to return to that third
party.
Having both long and short positions in an equity security portfolio is a common
way to create returns that are independent of market moves. One advantage of a
long and short portfolio is that the long and short positions may offset one
another in a manner that results in a lower net exposure to the direction of the
market. In addition, cash balances arising from the use of short selling
typically will be held in money market instruments.
-------------------------------------------------------------------------------------------------------------------
PERFORMANCE
-------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL CUMULATIVE
1 Year TOTAL RETURNS TOTAL RETURNS
Ended Inception (9/8/14) Inception (9/8/14)
10/31/15 to 10/31/15 to 10/31/15
FUND PERFORMANCE
NAV 7.60% 8.33% 9.60%
Market Price 7.59% 8.45% 9.73%
INDEX PERFORMANCE
S&P 500(R) Index 5.20% 5.49% 6.31%
-------------------------------------------------------------------------------------------------------------------
Total returns for the period since inception are calculated from the inception
date of the Fund. "Average Annual Total Returns" represent the average annual
change in value of an investment over the periods indicated. "Cumulative Total
Returns" represent the total change in value of an investment over the period
indicated.
The Fund's per share net asset value ("NAV") is the value of one share of the
Fund and is computed by dividing the value of all assets of the Fund (including
accrued interest and dividends), less all liabilities (including accrued
expenses and dividends declared but unpaid), by the total number of outstanding
shares. The price used to calculate market return ("Market Price") is determined
by using the midpoint between the highest bid and the lowest offer on the stock
exchange on which shares of the Fund are listed for trading as of the time that
the Fund's NAV is calculated. Since shares of the Fund did not trade in the
secondary market until after its inception, for the period from inception to the
first day of secondary market trading in shares of the Fund, the NAV of the Fund
is used as a proxy for the secondary market trading price to calculate market
returns. NAV and market price returns assume that all distributions have been
reinvested in the Fund at NAV and Market Price, respectively.
An index is a statistical composite that tracks a specified financial market or
sector. Unlike the Fund, the index does not actually hold a portfolio of
securities and therefore does not incur the expenses incurred by the Fund. These
expenses negatively impact the performance of the Fund. Also, market returns do
not include brokerage commissions that may be payable on secondary market
transactions. If brokerage commissions were included, market returns would be
lower. The total returns presented reflect the reinvestment of dividends on
securities in the index. The returns presented do not reflect the deduction of
taxes that a shareholder would pay on Fund distributions or the redemption or
sale of Fund shares. The investment return and principal value of shares of the
Fund will vary with changes in market conditions. Shares of the Fund may be
worth more or less than their original cost when they are redeemed or sold in
the market. The Fund's past performance is no guarantee of future performance.
Page 2
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
-----------------------------------------------------------
LONG-TERM
PORTFOLIO SECTOR ALLOCATION INVESTMENTS
-----------------------------------------------------------
Consumer Discretionary 12.0%
Consumer Staples 13.4
Energy 10.4
Financials 10.6
Health Care 15.5
Industrials 11.0
Information Technology 20.7
Materials 3.2
Telecommunication Services 2.8
Utilities 0.4
-------
Total 100.0%
=======
-----------------------------------------------------------
INVESTMENTS
PORTFOLIO SECTOR ALLOCATION SOLD SHORT
-----------------------------------------------------------
Consumer Discretionary 8.3%
Consumer Staples 9.6
Energy 6.8
Financials 42.5
Health Care 9.6
Industrials 8.6
Information Technology 7.4
Materials 5.8
Telecommunication Services 1.4
-------
Total 100.0%
=======
-----------------------------------------------------------
TOP TEN LONG-TERM INVESTMENTS % OF NET ASSETS
-----------------------------------------------------------
Apple, Inc. 4.1%
Exxon Mobil Corp. 2.4
Intel Corp. 2.3
AutoZone, Inc. 2.1
Clorox (The) Co. 2.1
Accenture PLC, Class A 2.0
Johnson & Johnson. 2.0
Unliver NV 2.0
Republic Services, Inc. 2.0
United Parcel Service, Inc; Class B 2.0
-------
Total 23.0%
=======
-----------------------------------------------------------
TOP TEN INVESTMENTS SOLD SHORT % OF NET ASSETS
-----------------------------------------------------------
SPDR S&P 500 ETF Trust -6.0%
iShares Russell 2000 ETF -1.9
iShares Core S&P 500 ETF -0.9
Reynolds American, Inc. -0.5
ConocoPhillips -0.4
Synder's-Lance, Inc. -0.4
Walt Disney (The) Co. -0.4
Ecolab, Inc. -0.4
Coca-Cola (The) Co. -0.4
Kellogg Co. -0.4
-------
Total -11.7%
=======
Page 3
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PERFORMANCE OF A $10,000 INITIAL INVESTMENT
SEPTEMBER 8, 2014 - OCTOBER 31, 2015
First Trust Long/Short Equity ETF S&P 500 Index
9/8/14 $10,000 $10,000
10/31/14 10,186 10,105
4/30/15 10,895 10,550
10/31/15 10,960 10,631
Performance figures assume reinvestment of all distributions and do not reflect
the deduction of taxes that a shareholder would pay on Fund distributions or the
redemption or sale of Fund shares. An index is a statistical composite that
tracks a specified financial market or sector. Unlike the Fund, the index does
not actually hold a portfolio of securities and therefore does not incur the
expenses incurred by the Fund. These expenses negatively impact the performance
of the Fund. The Fund's past performance does not predict future performance.
FREQUENCY DISTRIBUTION OF DISCOUNTS AND PREMIUMS
BID/ASK MIDPOINT VS. NAV THROUGH OCTOBER 31, 2015
The following Frequency Distribution of Discounts and Premiums charts are
provided to show the frequency at which the bid/ask midpoint price for the Fund
was at a discount or premium to the daily NAV. The following tables are for
comparative purposes only and represent the period September 9, 2014
(commencement of trading) through October 31, 2015. Shareholders may pay more
than NAV when they buy Fund shares and receive less than NAV when they sell
those shares because shares are bought and sold at current market price. Data
presented represents past performance and cannot be used to predict future
results.
------------------------------------------------------------------------------
NUMBER OF DAYS BID/ASK MIDPOINT AT/ABOVE NAV
------------------------------------------------------------------------------
FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00%
9/9/14 - 10/31/14 23 3 0 0
11/1/14 - 10/31/15 190 7 0 1
------------------------------------------------------------------------------
NUMBER OF DAYS BID/ASK MIDPOINT BELOW NAV
------------------------------------------------------------------------------
FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00%
9/9/14 - 10/31/14 9 4 0 0
11/1/14 - 10/31/15 41 12 0 0
Page 4
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
ANNUAL REPORT
OCTOBER 31, 2015
INVESTMENT MANAGER
The First Trust Advisors L.P. ("First Trust") Alternatives Investment team was
formed in July of 2011 and is headed by John Gambla, CFA, FRM, PRM and Rob
Guttschow, CFA. Prior to joining First Trust, Messrs. Gambla and Guttschow were
Co-Chief Investment Officers at Nuveen Hyde Park, a quantitative money manager.
The team focuses on systematic and disciplined strategies using a variety of
statistical techniques along with a fundamental overlay based upon their
combined 40+ years of investment experience. Currently the team manages/consults
for a variety of portfolios structured as exchanged-traded funds and separately
managed accounts in the United States, Canada, and Mexico.
PORTFOLIO MANAGEMENT TEAM
JOHN GAMBLA - CFA, FRM, PRM, SENIOR PORTFOLIO MANAGER OF FIRST TRUST,
FTA-ALTERNATIVES & ACTIVE MANAGEMENT TEAM
ROB GUTTSCHOW - CFA, SENIOR PORTFOLIO MANAGER OF FIRST TRUST,
FTA-ALTERNATIVES & ACTIVE MANAGEMENT TEAM
COMMENTARY
FIRST TRUST LONG/SHORT EQUITY ETF
The First Trust Long/Short Equity ETF (the "Fund" or "FTLS") is an actively
managed exchange-traded fund. The Fund's investment objective is to seek to
provide investors with long-term total return. The Fund intends to pursue its
investment objective by establishing long and short positions in a portfolio of
Equity Securities. Under normal circumstances, at least 80% of the Fund's net
assets (plus the amount of any borrowing for investment purposes) will be
exposed to U.S. exchange-listed equity securities of U.S. and non-U.S. companies
by investing in such securities directly and/or in U.S. exchange-traded funds
("ETFs") that provide exposure to such securities.
OVERALL MARKET RECAP
U.S. economic growth remained solid during the fiscal period from October 31,
2014 to October 31, 2015. During the period, U.S. GDP as reported on September
30, 2015 grew by an estimated 2.0% with the headline U.S. unemployment rate
falling in tandem, dropping from 5.7% in October of 2014 to 5.0% in October of
2015. The total number of new non-farm payroll jobs created during the fiscal
period was estimated at 2.8 million, or approximately 234,000 per month.
The overall steady performance of the U.S. economy and the declining
unemployment rate translated into modest gains for the S&P 500(R) Index, up
5.20% during the fiscal period. Interest rates, as measured by the U.S.
Government 10-Year Treasury, actually fell during the fiscal period with rates
falling by 0.19%, ending the period at 2.14%. The Federal Open Market Committee
("FOMC") left rates unchanged throughout the year, as global economic concerns
weighed heavily on potential future U.S. growth. In the early portion of the
fiscal period, a collapse in the price of oil and a simultaneous rally in the
U.S. dollar created deflationary pressures in the global economy and economic
headwinds for U.S. exports. Shortly thereafter the Greek debt restructuring
process took several unexpected twists and turns, which created market
uncertainty in Europe and further boosted the U.S. dollar rally. Finally, near
the end of the fiscal period, China's economy along with a variety of other
emerging market economies appeared to be slowing quickly, resulting in more
global growth uncertainty.
FUND PERFORMANCE - FTLS
The Fund returned 7.59% on a market price basis and 7.60% on a net asset value
("NAV") basis for the period from October 31, 2014 through October 31, 2015. The
Fund's benchmark, the S&P 500(R) Index ("Benchmark") returned 5.20% during the
fiscal period.
The fund's investment process involves constructing both a long and short
portfolio consisting of at least 80% in U.S. exchange-listed equity securities
of U.S. and foreign companies such as common stocks and ETFs. The portfolio
management team follows a systematic portfolio construction process designed to
balance the drivers of risk and return that exist between the long and short
positions. The investment process uses Sabrient/Gradient's EQR model ranking as
an input to determine holdings, both long and short. Additional proprietary
research is used to build the portfolio and to tactically manage both the
overall percentage and composition of the long and short exposures in the
portfolio.
For the fiscal period, the Fund returned 7.60% on an NAV basis, outperforming
its Benchmark by 2.40% net of all Fund fees. The Fund's net equity exposure
varied between 70% and 80%, with the long positions being held at a fully
invested position of approximately 100% and short positions varying between 20%
Page 5
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
ANNUAL REPORT
OCTOBER 31, 2015
and 30%. The Fund's overall outperformance versus its Benchmark was the result
of both the long and short positions adding value during the period. The long
portfolio in aggregate substantially outperformed the Benchmark during the
period and the shorts, in addition to reducing the overall market sensitivity of
the portfolio and thereby reducing the overall volatility of the Fund, also
added value by posting a negative total return during the performance period.
The best performing relative sector exposures for the Fund for the fiscal period
ended October 31, 2015 were the Energy and Industrials sector where the Fund
was, on average, underweight the Benchmark during the year. The worst performing
relative sector exposures for the Fund during the period were the Consumer
Discretionary and Financials sectors, where the Fund was, on average,
underweight the Benchmark.
MARKET AND FUND OUTLOOK
Today, we believe the Fund is well positioned to achieve its investment
objective of seeking to provide investors with long-term total return. The Fund
is invested in a broad array of U.S. equity securities with a net market
exposure of approximately 70% versus its unmanaged Benchmark's exposure of 100%.
We believe the Fund's combination of a broadly diversified portfolio, which is
long high quality stocks and short low quality stocks, as measured by an
earnings quality model, positions the Fund well to continue to achieve its
investment objective going forward.
Page 6
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
UNDERSTANDING YOUR FUND EXPENSES
OCTOBER 31, 2015 (UNAUDITED)
As a shareholder of First Trust Long/Short Equity ETF (the "Fund") you incur two
types of costs: (1) transaction costs; and (2) ongoing costs, including
management fees, distribution and/or service fees, if any, and other Fund
expenses. This Example is intended to help you understand your ongoing costs of
investing in the Fund and to compare these costs with the ongoing costs of
investing in other funds.
The Example is based on an investment of $1,000 invested at the beginning of the
period and held through the six-month period ended October 31, 2015.
ACTUAL EXPENSES
The first line in the following table provides information about actual account
values and actual expenses. You may use the information in this line, together
with the amount you invested, to estimate the expenses that you paid over the
period. Simply divide your account value by $1,000 (for example, an $8,600
account value divided by $1,000 = 8.6), then multiply the result by the number
in the first line under the heading entitled "Expenses Paid During the Six-Month
Period" to estimate the expenses you paid on your account during this six-month
period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line in the following table provides information about hypothetical
account values and hypothetical expenses based on the Fund's actual expense
ratio and an assumed rate of return of 5% per year before expenses, which is not
the Fund's actual return. The hypothetical account values and expenses may not
be used to estimate the actual ending account balance or expenses you paid for
the period. You may use this information to compare the ongoing costs of
investing in the Fund and other funds. To do so, compare this 5% hypothetical
example with the 5% hypothetical examples that appear in the shareholder reports
of the other funds.
Please note that the expenses shown in the table are meant to highlight your
ongoing costs only and do not reflect any transactional costs such as brokerage
commissions. Therefore, the second line in the table is useful in comparing
ongoing costs only, and will not help you determine the relative total costs of
owning different funds. In addition, if these transactional costs were included,
your costs would have been higher.
-------------------------------------------------------------------------------------------------------------------------
ANNUALIZED EXPENSES PAID
BEGINNING ENDING EXPENSE RATIO DURING THE
ACCOUNT VALUE ACCOUNT VALUE BASED ON THE SIX-MONTH
MAY 1, 2015 OCTOBER 31, 2015 SIX-MONTH PERIOD PERIOD (a)
-------------------------------------------------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF
Actual $1,000.00 $1,006.00 1.46% $7.38
Hypothetical (5% return before expenses) $1,000.00 $1,017.85 1.46% $7.43
(a) Expenses are equal to the annualized expense ratio as indicated in the
table, multiplied by the average account value over the period (May 1,
2015 through October 31, 2015), multiplied by 184/365. Hypothetical
expenses are assumed for the most recent half-year period.
Page 7
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 2015
SHARES DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
COMMON STOCKS - 90.4%
AEROSPACE & DEFENSE - 1.0%
2,242 Boeing (The) Co. (a)........................................................................ $ 331,973
------------
AIR FREIGHT & LOGISTICS - 2.0%
6,322 United Parcel Service, Inc., Class B (a).................................................... 651,292
------------
AIRLINES - 3.3%
5,677 Alaska Air Group, Inc. (a).................................................................. 432,871
5,495 JetBlue Airways Corp. (b)................................................................... 136,496
2,121 Ryanair Holdings PLC........................................................................ 165,841
9,261 Virgin America, Inc. (b).................................................................... 329,784
------------
1,064,992
------------
AUTO COMPONENTS - 0.4%
4,924 Tower International, Inc.................................................................... 135,262
------------
BANKS - 7.4%
19,657 Banco Santander S.A., ADR................................................................... 108,900
11,661 Barclays PLC, ADR........................................................................... 165,936
2,815 CIT Group, Inc. (a)......................................................................... 121,045
3,737 Citigroup, Inc. (a)......................................................................... 198,696
7,657 FCB Financial Holdings, Inc. (b)............................................................ 272,283
10,660 HSBC Holdings PLC, ADR (a).................................................................. 416,486
8,841 JPMorgan Chase & Co. (a).................................................................... 568,034
13,126 U.S. Bancorp (a)............................................................................ 553,655
------------
2,405,035
------------
BIOTECHNOLOGY - 3.4%
2,321 Amgen, Inc. (a)............................................................................. 367,136
3,975 Gilead Sciences, Inc. (a)................................................................... 429,817
6,179 Halozyme Therapeutics, Inc. (b)............................................................. 96,701
22,262 PDL BioPharma, Inc.......................................................................... 101,960
10,819 Vanda Pharmaceuticals, Inc. (b)............................................................. 116,196
------------
1,111,810
------------
BUILDING PRODUCTS - 1.0%
5,741 Masco Corp.................................................................................. 166,489
2,062 Universal Forest Products, Inc.............................................................. 149,763
------------
316,252
------------
CHEMICALS - 0.9%
2,904 Dow Chemical (The) Co....................................................................... 150,050
1,464 LyondellBasell Industries NV (a)............................................................ 136,020
------------
286,070
------------
COMMERCIAL SERVICES & SUPPLIES - 2.0%
15,040 Republic Services, Inc. (a)................................................................. 657,850
------------
CONSUMER FINANCE - 0.6%
2,617 Capital One Financial Corp.................................................................. 206,481
------------
CONTAINERS & PACKAGING - 0.4%
8,884 Graphic Packaging Holding Co. (a)........................................................... 125,797
------------
DIVERSIFIED CONSUMER SERVICES - 1.7%
3,517 2U, Inc. (b)................................................................................ 73,787
12,559 H&R Block, Inc.............................................................................. 467,948
------------
541,735
------------
Page 8 See Notes to Financial Statements
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
SHARES DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
COMMON STOCKS (CONTINUED)
DIVERSIFIED TELECOMMUNICATION SERVICES - 1.0%
2,657 Atlantic Tele-Network, Inc.................................................................. $ 203,048
4,665 Centurylink, Inc. (a)....................................................................... 131,600
------------
334,648
------------
FOOD & STAPLES RETAILING - 3.2%
4,497 Casey's General Stores, Inc................................................................. 477,671
899 Costco Wholesale Corp. (a).................................................................. 142,150
2,541 Ingles Markets, Inc......................................................................... 126,898
5,075 Wal-Mart Stores, Inc. (a)................................................................... 290,493
------------
1,037,212
------------
FOOD PRODUCTS - 3.4%
10,462 Campbell Soup Co............................................................................ 531,365
3,125 Hormel Foods Corp. (a)...................................................................... 211,094
5,744 Pilgrim's Pride Corp. (a)................................................................... 109,078
2,841 Pinnacle Foods, Inc. (a).................................................................... 125,231
3,083 Tyson Foods, Inc., Class A.................................................................. 136,762
------------
1,113,530
------------
HEALTH CARE EQUIPMENT & SUPPLIES - 1.0%
1,116 C.R. Bard, Inc.............................................................................. 207,967
1,375 DexCom, Inc. (b)............................................................................ 114,565
------------
322,532
------------
HEALTH CARE PROVIDERS & SERVICES - 3.2%
4,521 Amsurg Corp. (a) (b)........................................................................ 316,877
2,245 Cardinal Health, Inc........................................................................ 184,539
1,895 Chemed Corp................................................................................. 298,064
2,737 LHC Group, Inc. (b)......................................................................... 123,343
1,817 Molina Healthcare, Inc. (b)................................................................. 112,654
------------
1,035,477
------------
HOTELS, RESTAURANTS & LEISURE - 1.0%
3,439 Brinker International, Inc.................................................................. 156,509
3,218 Las Vegas Sands Corp........................................................................ 159,323
------------
315,832
------------
HOUSEHOLD PRODUCTS - 2.1%
5,545 Clorox (The) Co............................................................................. 676,157
------------
INTERNET & CATALOG RETAIL - 1.2%
4,315 Liberty Media Corp. - Interactive, Class A (a) (b).......................................... 118,102
3,199 Liberty Ventures, Series A (a) (b).......................................................... 139,380
101 priceline.com, Inc. (a) (b)................................................................. 146,878
------------
404,360
------------
INTERNET SOFTWARE & SERVICES - 6.6%
740 Alphabet, Inc., Class A (b)................................................................. 545,669
755 Alphabet, Inc., Class C (b)................................................................. 536,662
3,345 Benefitfocus, Inc. (b)...................................................................... 106,906
20,541 eBay, Inc. (a) (b).......................................................................... 573,094
5,044 VeriSign, Inc. (a) (b)...................................................................... 406,546
------------
2,168,877
------------
See Notes to Financial Statements Page 9
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
SHARES DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
COMMON STOCKS (CONTINUED)
IT SERVICES - 2.9%
6,224 Accenture PLC, Class A (a).................................................................. 667,213
1,135 Global Payments, Inc. (a)................................................................... 154,825
1,762 Visa, Inc., Class A (a)..................................................................... 136,696
------------
958,734
------------
LIFE SCIENCES TOOLS & SERVICES - 0.4%
2,940 INC Research Holdings, Inc. (b)............................................................. 122,627
------------
MACHINERY - 0.4%
2,400 AGCO Corp................................................................................... 116,136
------------
METALS & MINING - 0.8%
1,546 Kaiser Aluminum Corp........................................................................ 125,674
8,465 Ternium S.A., ADR (a)....................................................................... 121,642
------------
247,316
------------
MULTILINE RETAIL - 0.7%
2,915 Target Corp................................................................................. 224,980
------------
OIL, GAS & CONSUMABLE FUELS - 6.5%
9,323 Exxon Mobil Corp. (a)....................................................................... 771,385
6,966 Marathon Petroleum Corp..................................................................... 360,839
3,819 PBF Energy, Inc. (a)........................................................................ 129,846
1,378 PetroChina Co., Ltd., ADR (a)............................................................... 108,352
1,824 Tesoro Corp................................................................................. 195,040
8,364 Valero Energy Corp. (a)..................................................................... 551,355
------------
2,116,817
------------
PERSONAL PRODUCTS - 2.0%
14,663 Unilever NV................................................................................. 659,542
------------
PHARMACEUTICALS - 7.3%
6,544 Johnson & Johnson (a)....................................................................... 661,140
2,404 Merck & Co., Inc............................................................................ 131,403
6,315 Novartis AG, ADR (a)........................................................................ 571,066
11,416 Novo Nordisk A/S, ADR (a)................................................................... 607,103
2,720 Taro Pharmaceutical Industries Ltd. (b)..................................................... 394,998
------------
2,365,710
------------
PROFESSIONAL SERVICES - 0.4%
2,675 Insperity, Inc. (a)......................................................................... 124,281
------------
SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT - 3.4%
4,876 Advanced Energy Industries, Inc. (b)........................................................ 137,893
22,222 Intel Corp. (a)............................................................................. 752,437
8,296 NVIDIA Corp. (a)............................................................................ 235,358
------------
1,125,688
------------
SOFTWARE - 2.8%
18,235 A10 Networks, Inc. (b)...................................................................... 130,927
7,624 Activision Blizzard, Inc. (a)............................................................... 265,010
1,383 ANSYS, Inc. (a) (b)......................................................................... 131,814
1,780 Electronic Arts, Inc. (a) (b)............................................................... 128,285
8,476 King Digital Entertainment PLC.............................................................. 126,801
1,902 SS&C Technologies Holdings, Inc. (a)........................................................ 141,033
------------
923,870
------------
Page 10 See Notes to Financial Statements
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
SHARES/
UNITS DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
COMMON STOCKS (CONTINUED)
SPECIALTY RETAIL - 6.7%
865 AutoZone, Inc. (a) (b)...................................................................... $ 678,515
7,483 Barnes & Noble, Inc. (a).................................................................... 97,204
4,157 GameStop Corp., Class A (a)................................................................. 191,513
3,602 Home Depot (The), Inc. (a).................................................................. 445,351
2,036 Outerwall, Inc. (a)......................................................................... 122,160
11,135 Pep Boys-Manny Moe & Jack/The (b)........................................................... 167,470
4,845 Rent-A-Center, Inc.......................................................................... 89,100
7,997 Ross Stores, Inc............................................................................ 404,488
------------
2,195,801
------------
TECHNOLOGY HARDWARE, STORAGE & PERIPHERALS - 4.4%
11,195 Apple, Inc. (a)............................................................................. 1,337,803
1,599 Western Digital Corp........................................................................ 106,845
------------
1,444,648
------------
TOBACCO - 2.5%
6,501 Altria Group, Inc. (a)...................................................................... 393,116
4,676 Philip Morris International, Inc............................................................ 413,358
------------
806,474
------------
TRANSPORTATION INFRASTRUCTURE - 0.7%
2,642 Grupo Aeroportuario del Pacifico SAB de CV, ADR............................................. 240,607
------------
WIRELESS TELECOMMUNICATION SERVICES - 1.7%
17,242 Vodafone Group PLC, ADR (a)................................................................. 568,469
------------
TOTAL COMMON STOCKS......................................................................... 29,484,874
(Cost $28,979,453) ------------
REAL ESTATE INVESTMENT TRUSTS - 2.4%
REAL ESTATE INVESTMENT TRUSTS - 2.4%
6,619 American Capital Agency Corp................................................................ 118,017
6,781 Host Hotels & Resorts, Inc. (a)............................................................. 117,515
7,203 Paramount Group, Inc. (a)................................................................... 127,997
617 Public Storage (a).......................................................................... 141,577
683 Simon Property Group, Inc. (a).............................................................. 137,597
1,923 Welltower, Inc. (a)......................................................................... 124,745
------------
TOTAL REAL ESTATE INVESTMENT TRUSTS......................................................... 767,448
(Cost $769,015) ------------
MASTER LIMITED PARTNERSHIPS - 5.1%
CHEMICALS - 1.1%
3,325 Terra Nitrogen Co, L.P. (a)................................................................. 351,718
------------
GAS UTILITIES - 0.4%
2,862 AmeriGas Partners, L.P...................................................................... 122,036
------------
OIL, GAS & CONSUMABLE FUELS - 3.6%
3,665 Alliance Holdings GP, L.P. (a).............................................................. 107,238
13,578 Alon USA Partners L.P. (a).................................................................. 334,154
1,880 Buckeye Partners, L.P. (a).................................................................. 127,520
1,886 Magellan Midstream Partners, L.P. (a)....................................................... 120,346
14,465 Northern Tier Energy L.P. (a)............................................................... 388,241
See Notes to Financial Statements Page 11
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
SHARES DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
MASTER LIMITED PARTNERSHIPS (CONTINUED)
OIL, GAS & CONSUMABLE FUELS (CONTINUED)
2,303 TC Pipelines, L.P. (a)...................................................................... $ 118,973
------------
1,196,472
------------
TOTAL MASTER LIMITED PARTNERSHIPS........................................................... 1,670,226
(Cost $1,712,575) ------------
TOTAL LONG-TERM INVESTMENTS - 97.9%......................................................... 31,922,548
(Cost $31,461,043) (c) ------------
COMMON STOCKS SOLD SHORT - (17.7%)
AEROSPACE & DEFENSE - (0.2%)
(988) AAR Corp.................................................................................... (22,418)
(1,289) Textron, Inc................................................................................ (54,357)
------------
(76,775)
------------
AIR FREIGHT & LOGISTICS - (0.3%)
(15,804) UTi Worldwide, Inc. (b)..................................................................... (112,683)
------------
AUTO COMPONENTS - (0.2%)
(1,262) Johnson Controls, Inc....................................................................... (57,017)
------------
AUTOMOBILES - (0.3%)
(2,804) General Motors Co........................................................................... (97,888)
------------
BANKS - (1.0%)
(2,318) Community Bank System, Inc.................................................................. (94,482)
(1,507) CVB Financial Corp.......................................................................... (26,297)
(4,902) Fifth Third Bancorp......................................................................... (93,383)
(9,864) Valley National Bancorp..................................................................... (103,572)
------------
(317,734)
------------
BEVERAGES - (0.9%)
(3,188) Coca-Cola (The) Co.......................................................................... (135,012)
(2,478) Coca-Cola Enterprises, Inc.................................................................. (127,221)
(274) Constellation Brands, Inc................................................................... (36,935)
------------
(299,168)
------------
BIOTECHNOLOGY - (1.1%)
(792) AbbVie, Inc................................................................................. (47,164)
(684) ACADIA Pharmaceuticals, Inc. (b)............................................................ (23,817)
(7,499) Agenus, Inc. (b)............................................................................ (34,195)
(383) Alkermes PLC (b)............................................................................ (27,545)
(239) Alnylam Pharmaceuticals, Inc. (b)........................................................... (20,542)
(1,577) Celldex Therapeutics, Inc. (b).............................................................. (19,019)
(506) Chimerix, Inc. (b).......................................................................... (19,825)
(5,027) Ironwood Pharmaceuticals, Inc. (b).......................................................... (57,107)
(826) Ophthotech Corp. (b)........................................................................ (41,242)
(838) Portola Pharmaceuticals, Inc. (b)........................................................... (39,897)
(892) PTC Therapeutics, Inc. (b).................................................................. (22,184)
(3,174) Sangamo BioSciences, Inc. (b)............................................................... (22,377)
------------
(374,914)
------------
CHEMICALS - (1.3%)
(897) Air Products & Chemicals, Inc............................................................... (124,665)
(1,128) Ecolab, Inc................................................................................. (135,755)
(1,157) Praxair, Inc................................................................................ (128,531)
(323) Valspar Corp./The........................................................................... (26,147)
------------
(415,098)
------------
Page 12 See Notes to Financial Statements
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
SHARES DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
COMMON STOCKS SOLD SHORT (CONTINUED)
COMMERCIAL SERVICES & SUPPLIES - (0.5%)
(1,028) Matthews International Corp................................................................. $ (59,346)
(899) Stericycle, Inc. (b)........................................................................ (109,112)
------------
(168,458)
------------
CONSTRUCTION & ENGINEERING - (0.5%)
(784) Granite Construction, Inc................................................................... (25,746)
(7,063) KBR, Inc.................................................................................... (130,242)
------------
(155,988)
------------
CONSUMER FINANCE - (0.2%)
(2,988) Ally Financial, Inc. (b).................................................................... (59,521)
------------
CONTAINERS & PACKAGING - (0.2%)
(772) AptarGroup, Inc............................................................................. (56,788)
------------
DIVERSIFIED CONSUMER SERVICES - (0.2%)
(1,097) Houghton Mifflin Harcourt Co. (b)........................................................... (21,490)
(458) Steiner Leisure Ltd. (b).................................................................... (29,019)
------------
(50,509)
------------
ELECTRONIC EQUIPMENT, INSTRUMENTS & COMPONENTS - (0.4%)
(1,978) AVX Corp.................................................................................... (26,703)
(3,733) Corning, Inc................................................................................ (69,434)
(786) Itron, Inc. (b)............................................................................. (28,870)
------------
(125,007)
------------
ENERGY EQUIPMENT & SERVICES - (0.1%)
(412) SEACOR Holdings, Inc. (b)................................................................... (24,069)
------------
FOOD PRODUCTS - (1.3%)
(3,222) Darling Ingredients, Inc. (b)............................................................... (32,607)
(1,898) Kellogg Co.................................................................................. (133,847)
(2,826) Mondelez International, Inc., Class A....................................................... (130,448)
(3,877) Snyder's-Lance, Inc......................................................................... (137,788)
------------
(434,690)
------------
HEALTH CARE EQUIPMENT & SUPPLIES - (0.7%)
(1,038) Alere, Inc. (b)............................................................................. (47,872)
(1,274) Cardiovascular Systems, Inc. (b)............................................................ (17,454)
(1,169) CONMED Corp................................................................................. (47,415)
(1,267) K2M Group Holdings, Inc. (b)................................................................ (23,123)
(1,622) Spectranetics Corp./The (b)................................................................. (19,821)
(372) St. Jude Medical, Inc....................................................................... (23,737)
(3,083) Wright Medical Group NV (b)................................................................. (59,594)
------------
(239,016)
------------
HEALTH CARE PROVIDERS & SERVICES - (0.3%)
(642) Acadia Healthcare Co., Inc. (b)............................................................. (39,425)
(663) Air Methods Corp. (b)....................................................................... (27,137)
(489) Community Health Systems, Inc. (b).......................................................... (13,711)
(1,913) Select Medical Holdings Corp................................................................ (21,617)
------------
(101,890)
------------
HOTELS, RESTAURANTS & LEISURE - (0.2%)
(327) DineEquity, Inc............................................................................. (27,288)
(2,604) Wendy's Co./The............................................................................. (23,853)
------------
(51,141)
------------
See Notes to Financial Statements Page 13
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
SHARES DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
COMMON STOCKS SOLD SHORT (CONTINUED)
HOUSEHOLD DURABLES - (0.1%)
(764) Newell Rubbermaid, Inc...................................................................... $ (32,417)
------------
INTERNET SOFTWARE & SERVICES - (0.4%)
(742) Cornerstone OnDemand, Inc. (b).............................................................. (23,373)
(696) Demandware, Inc. (b)........................................................................ (39,463)
(3,423) Monster Worldwide, Inc. (b)................................................................. (21,462)
(1,692) Yahoo!, Inc. (b)............................................................................ (60,269)
------------
(144,567)
------------
IT SERVICES - (0.8%)
(159) Alliance Data Systems Corp. (b)............................................................. (47,272)
(614) Computer Sciences Corp...................................................................... (40,886)
(3,467) PayPal Holdings, Inc. (b)................................................................... (124,847)
(814) VeriFone Systems, Inc. (b).................................................................. (24,534)
(2,389) Xerox Corp.................................................................................. (22,433)
------------
(259,972)
------------
LIFE SCIENCES TOOLS & SERVICES - (0.1%)
(1,297) Bruker Corp. (b)............................................................................ (23,826)
------------
MACHINERY - (0.1%)
(822) Mueller Industries, Inc..................................................................... (25,910)
(2,823) Titan International, Inc.................................................................... (20,043)
------------
(45,953)
------------
MEDIA - (0.8%)
(3,266) Global Eagle Entertainment, Inc. (b)........................................................ (43,503)
(1,023) Omnicom Group, Inc.......................................................................... (76,643)
(1,209) Walt Disney (The) Co........................................................................ (137,512)
------------
(257,658)
------------
MULTILINE RETAIL - (0.2%)
(1,004) Macy's, Inc................................................................................. (51,184)
------------
OIL, GAS & CONSUMABLE FUELS - (1.8%)
(2,614) ConocoPhillips.............................................................................. (139,457)
(796) Diamondback Energy, Inc. (b)................................................................ (58,777)
(438) Hess Corp................................................................................... (24,620)
(2,592) Matador Resources Co. (b)................................................................... (66,640)
(1,363) Memorial Resource Development Corp. (b)..................................................... (24,111)
(1,293) Newfield Exploration Co. (b)................................................................ (51,966)
(1,792) Occidental Petroleum Corp................................................................... (133,576)
(3,973) QEP Resources, Inc.......................................................................... (61,422)
(472) SemGroup Corp., Class A..................................................................... (21,500)
(1,479) Southwestern Energy Co. (b)................................................................. (16,328)
------------
(598,397)
------------
PAPER & FOREST PRODUCTS - (0.2%)
(1,428) International Paper Co...................................................................... (60,961)
------------
PHARMACEUTICALS - (0.4%)
(1,576) Eli Lilly & Co.............................................................................. (128,554)
(617) Tetraphase Pharmaceuticals, Inc. (b)........................................................ (5,572)
------------
(134,126)
------------
Page 14 See Notes to Financial Statements
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
SHARES DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
COMMON STOCKS SOLD SHORT (CONTINUED)
PROFESSIONAL SERVICES - (0.6%)
(279) ManpowerGroup, Inc.......................................................................... $ (25,607)
(2,709) Nielsen Holdings PLC........................................................................ (128,704)
(438) Verisk Analytics, Inc. (b).................................................................. (31,365)
------------
(185,676)
------------
REAL ESTATE MANAGEMENT & DEVELOPMENT - (0.1%)
(207) Howard Hughes Corp./The (b)................................................................. (25,581)
------------
ROAD & RAIL - (0.1%)
(323) JB Hunt Transport Services, Inc............................................................. (24,668)
(1,513) Roadrunner Transportation Systems, Inc. (b)................................................. (16,098)
------------
(40,766)
------------
SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT - (0.1%)
(2,499) Cypress Semiconductor Corp. (b)............................................................. (26,339)
------------
SOFTWARE - (0.1%)
(632) Interactive Intelligence Group, Inc. (b).................................................... (20,439)
(1,122) Varonis Systems, Inc. (b)................................................................... (17,918)
------------
(38,357)
------------
SPECIALTY RETAIL - (0.4%)
(703) Aaron's, Inc................................................................................ (17,343)
(938) Best Buy Co., Inc........................................................................... (32,858)
(409) Genesco, Inc. (b)........................................................................... (25,624)
(674) Tiffany & Co................................................................................ (55,565)
------------
(131,390)
------------
TECHNOLOGY HARDWARE, STORAGE & PERIPHERALS - (0.2%)
(3,013) Hewlett-Packard Co. (b)..................................................................... (81,230)
------------
TEXTILES, APPAREL & LUXURY GOODS - (0.1%)
(574) Columbia Sportswear Co...................................................................... (31,484)
------------
THRIFTS & MORTGAGE FINANCE - (0.3%)
(6,162) TFS Financial Corp.......................................................................... (108,205)
------------
TOBACCO - (0.5%)
(3,054) Reynolds American, Inc...................................................................... (147,569)
------------
WIRELESS TELECOMMUNICATION SERVICES - (0.4%)
(4,424) Telephone & Data Systems, Inc............................................................... (126,703)
------------
TOTAL COMMON STOCKS SOLD SHORT.............................................................. (5,770,715)
(Proceeds $(5,942,616)) ------------
REAL ESTATE INVESTMENT TRUSTS SOLD SHORT - (1.3%)
REAL ESTATE INVESTMENT TRUSTS - (1.3%)
(737) AvalonBay Communities, Inc.................................................................. (128,850)
(94) Equinix, Inc................................................................................ (27,888)
(3,109) General Growth Properties, Inc.............................................................. (90,006)
(1,739) Redwood Trust, Inc.......................................................................... (23,094)
(2,888) Starwood Waypoint Residential Trust......................................................... (71,045)
(5,609) Two Harbors Investment Corp................................................................. (47,452)
(273) Vornado Realty Trust........................................................................ (27,450)
(423) WP Carey, Inc............................................................................... (26,805)
------------
TOTAL REAL ESTATE INVESTMENT TRUSTS SOLD SHORT.............................................. (442,590)
(Proceeds $(445,845)) ------------
See Notes to Financial Statements Page 15
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
SHARES/
UNITS DESCRIPTION VALUE
----------- -------------------------------------------------------------------------------------------- ------------
EXCHANGE-TRADED FUNDS SOLD SHORT - (9.0%)
CAPITAL MARKETS - (9.0%)
(1,327) iShares Core S&P 500 ETF.................................................................... $ (277,409)
(5,254) iShares Russell 2000 ETF.................................................................... (605,997)
(698) iShares Russell 2000 Growth ETF............................................................. (98,802)
(9,355) SPDR S&P 500 ETF Trust...................................................................... (1,945,185)
------------
TOTAL EXCHANGE-TRADED FUNDS SOLD SHORT...................................................... (2,927,393)
(Proceeds $(2,881,591)) ------------
TOTAL INVESTMENTS SOLD SHORT - (28.0%)...................................................... (9,140,698)
(Proceeds $(9,270,052)) ------------
NET OTHER ASSETS AND LIABILITIES - 30.1%.................................................... 9,825,714
------------
NET ASSETS - 100.0%......................................................................... $ 32,607,564
============
(a) The security or a portion of the security is segregated as collateral for
investments sold short.
(b) Non-income producing security.
(c) Aggregate cost for federal income tax purposes is $31,582,534. As of
October 31, 2015, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was
$1,310,826 and the aggregate gross unrealized depreciation for all
securities in which there was an excess of tax cost over value was
$970,812.
ADR American Depositary Receipt
----------------------------
VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of October 31,
2015 is as follows (see Note 2A - Portfolio Valuation in the Notes to Financial
Statements):
ASSETS TABLE
LEVEL 2 LEVEL 3
TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
INVESTMENTS 10/31/2015 PRICES INPUTS INPUTS
--------------------------------------------------- ------------- ------------- -------------- --------------
Common Stocks*..................................... $ 29,484,874 $ 29,484,874 $ -- $ --
Real Estate Investment Trusts...................... 767,448 767,448 -- --
Master Limited Partnerships*....................... 1,670,226 1,670,226 -- --
------------- ------------- -------------- --------------
Total Investments.................................. $ 31,922,548 $ 31,922,548 $ -- $ --
============= ============= ============== ==============
LIABILITIES TABLE
LEVEL 2 LEVEL 3
TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
10/31/2015 PRICES INPUTS INPUTS
--------------------------------------------------- ------------- ------------- -------------- --------------
Common Stocks Sold Short*.......................... $ (5,770,715) $ (5,770,715) $ -- $ --
Real Estate Investment Trusts Sold Short........... (442,590) (442,590) -- --
Exchange-Traded Funds Sold Short*.................. (2,927,393) (2,927,393) -- --
------------- ------------- -------------- --------------
Total Investments Sold Short....................... $ (9,140,698) $ (9,140,698) $ -- $ --
============= ============= ============== ==============
* 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 October 31, 2015.
Page 16 See Notes to Financial Statements
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 2015
ASSETS:
Investments, at value (Cost $31,461,043)................................ $ 31,922,548
Cash.................................................................... 414,050
Restricted cash......................................................... 9,245,221
Receivables:
Investment securities sold........................................... 152,606
Dividends............................................................ 32,532
Dividend reclaims.................................................... 1,946
Other assets............................................................ 3,488
-----------------
Total Assets......................................................... 41,772,391
-----------------
LIABILITIES:
Investments sold short, at value (proceeds $9,270,052).................. 9,140,698
Payables:
Investment advisory fees............................................. 23,426
Other liabilities....................................................... 703
-----------------
Total Liabilities.................................................... 9,164,827
-----------------
NET ASSETS.............................................................. $ 32,607,564
=================
NET ASSETS CONSIST OF:
Paid-in capital......................................................... $ 32,218,776
Par value............................................................... 10,000
Accumulated net investment income (loss)................................ (8,788)
Accumulated net realized gain (loss) on investments and investments
sold short........................................................... (203,283)
Net unrealized appreciation (depreciation) on investments and
investments sold short............................................... 590,859
-----------------
NET ASSETS.............................................................. $ 32,607,564
=================
NET ASSET VALUE, per share.............................................. $ 32.61
=================
Number of shares outstanding (unlimited number of
shares authorized, par value $0.01 per share)........................ 1,000,002
=================
See Notes to Financial Statements Page 17
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED OCTOBER 31, 2015
INVESTMENT INCOME:
Dividends............................................................... $ 256,161
Foreign tax withholding................................................. (1,100)
-----------------
Total investment income.............................................. 255,061
-----------------
EXPENSES:
Investment advisory fees................................................ 130,017
Dividend expense on investments sold short.............................. 71,499
-----------------
Total expenses....................................................... 201,516
-----------------
NET INVESTMENT INCOME (LOSS)............................................ 53,545
-----------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on:
Investments.......................................................... (303,345)
In-kind redemptions.................................................. 418,430
Investments sold short............................................... 58,189
-----------------
Net realized gain (loss)................................................ 173,274
-----------------
Net change in unrealized appreciation (depreciation) on:................
Investments.......................................................... 410,230
Investments sold short............................................... 131,530
-----------------
Net change in unrealized appreciation (depreciation).................... 541,760
-----------------
NET REALIZED AND UNREALIZED GAIN (LOSS)................................. 715,034
-----------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING
FROM OPERATIONS...................................................... $ 768,579
=================
Page 18 See Notes to Financial Statements
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE FOR THE PERIOD
YEAR 9/8/2014 (a)
ENDED THROUGH
10/31/2015 10/31/2014
----------------- ---------------
OPERATIONS:
Net investment income (loss)............................................ $ 53,545 $ 4,614
Net realized gain (loss)................................................ 173,274 1,726
Net change in unrealized appreciation (depreciation).................... 541,760 49,099
----------------- ---------------
Net increase (decrease) in net assets resulting from operations......... 768,579 55,439
----------------- ---------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income................................................... (62,116) (1,620)
Net realized gain....................................................... (2,000) --
----------------- ---------------
Total distributions to shareholders..................................... (64,116) (1,620)
----------------- ---------------
SHAREHOLDER TRANSACTIONS:
Proceeds from shares sold............................................... 33,730,801 3,000,060
Cost of shares redeemed................................................. (4,881,579) --
----------------- ---------------
Net increase (decrease) in net assets resulting from
shareholder transactions............................................. 28,849,222 3,000,060
----------------- ---------------
Total increase (decrease) in net assets................................. 29,553,685 3,053,879
NET ASSETS:
Beginning of year....................................................... 3,053,879 --
----------------- ---------------
End of year............................................................. $ 32,607,564 $ 3,053,879
================= ===============
Accumulated net investment income (loss) at end of year................. $ (8,788) $ 2,994
================= ===============
CHANGES IN SHARES OUTSTANDING:
Shares outstanding, beginning of period................................. 100,002 --
Shares sold............................................................. 1,050,000 100,002
Shares redeemed......................................................... (150,000) --
----------------- ---------------
Shares outstanding, end of period....................................... 1,000,002 100,002
================= ===============
(a) Inception date is consistent with the commencement of investment
operations and is the date the initial creation units were established.
See Notes to Financial Statements Page 19
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FOR THE PERIOD
YEAR ENDED 9/8/2014 (a)
OCTOBER 31, THROUGH
2015 10/31/2014
-------------- --------------
Net asset value, beginning of period.......... $ 30.54 $ 30.00
---------- ----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss).................. 0.19 0.05
Net realized and unrealized gain (loss)....... 2.12 0.51
---------- ----------
Total from investment operations.............. 2.31 0.56
---------- ----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income......................... (0.22) (0.02)
Net realized gain............................. (0.02) --
---------- ----------
Total distributions........................... (0.24) (0.02)
---------- ----------
Net asset value, end of period................ $ 32.61 $ 30.54
========== ==========
TOTAL RETURN (b).............................. 7.60% 1.86%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's).......... $ 32,608 $ 3,054
RATIOS TO AVERAGE NET ASSETS:
Ratio of total expenses to average net
assets..................................... 1.47% 1.17% (c)
Ratio of total expenses to average net
assets.....................................
excluding dividend expense................. 0.95% 0.95% (c)
Ratio of net investment income (loss) to
average net assets......................... 0.39% 1.08% (c)
Portfolio turnover rate (d)................... 267% 1%
(a) Inception date is consistent with the commencement of investment
operations and is the date the initial creation units were established.
(b) Total return is calculated assuming an initial investment made at the net
asset value at the beginning of the period, reinvestment of all
distributions at net asset value during the period, and redemption at net
asset value on the last day of the period. The returns presented do not
reflect the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption or sale of Fund shares. Total return is
calculated for the time period presented and is not annualized for periods
of less than a year.
(c) Annualized.
(d) Portfolio turnover is calculated for the time period presented and is not
annualized for periods of less than a year and does not include securities
received or delivered from processing creations or redemptions and in-kind
transactions.
Page 20 See Notes to Financial Statements
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015
1. ORGANIZATION
First Trust Exchange-Traded Fund III (the "Trust") is a non-diversified open-end
management investment company organized as a Massachusetts business trust on
January 9, 2008, and is registered with the Securities and Exchange Commission
under the Investment Company Act of 1940, as amended (the "1940 Act").
The Trust currently consists of four funds that are offering shares. This report
covers the First Trust Long/Short Equity ETF (the "Fund"), which trades under
the ticker "FTLS" on the NYSE Arca, Inc. Unlike conventional mutual funds, the
Fund issues and redeems shares on a continuous basis, at net asset value
("NAV"), only in large specified blocks consisting of 50,000 shares called a
"Creation Unit." Creation Units are issued and redeemed for securities in which
the Fund invests or for cash or, in certain circumstances, a combination of
both. Except when aggregated in Creation Units, the shares are not redeemable
securities of the Fund.
The investment objective of the Fund is to seek to provide investors with
long-term total return. The Fund pursues its investment objective by
establishing long and short positions in a portfolio of equity securities. Under
normal circumstances, at least 80% of the Fund's net assets (plus the amount of
any borrowing for investment purposes) will be exposed to U.S. exchange-listed
equity securities of U.S. and foreign companies by investing in such securities
directly and/or in U.S. exchange-traded funds ("ETFs") that provide exposure to
such securities. The equity securities held by the Fund may include U.S.
exchange-listed equity securities of foreign issuers, as well as investments in
the equity securities of foreign issuers that are in the form of depositary
receipts. There can be no assurance that the Fund will achieve its investment
objective. The Fund may not be appropriate for all investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The Fund, which is an investment company within the scope of Financial
Accounting Standards Board ("FASB") Accounting Standards Update 2013-08, follows
accounting and reporting guidance under FASB Accounting Standards Codification
Topic 946, "Financial Services-Investment Companies." The following is a summary
of significant accounting policies consistently followed by the Fund in the
preparation of the financial statements. The preparation of the 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 Fund's NAV is determined daily as of the close of regular trading on the New
York Stock Exchange ("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 Fund's NAV is calculated by dividing the value of all
assets of the Fund (including accrued interest and dividends), less all
liabilities (including accrued expenses and dividends declared but unpaid), by
the total number of shares outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value. Market
value prices represent last sale or official closing prices from a national or
foreign exchange (i.e., a regulated market) and are primarily obtained from
third-party pricing services. Fair value prices represent any prices not
considered market value prices and are either obtained from a third-party
pricing service or are determined by the Pricing Committee of the Fund's
investment advisor, First Trust Advisors L.P. ("First Trust" or the "Advisor"),
in accordance with valuation procedures adopted by the Trust's Board of
Trustees, and in accordance with provisions of the 1940 Act. Investments valued
by the Advisor's Pricing Committee, if any, are footnoted as such in the
footnotes to the Portfolio of Investments. The Fund's investments are valued as
follows:
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 one or 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 fair valued at the
mean of their most recent bid and asked price, if available, and otherwise
at their closing bid price.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Trust's Board of Trustees or its
delegate, the Advisor's Pricing Committee, at fair value. These securities
generally include, but are not limited to, restricted securities (securities
which may not be publicly sold without registration under the Securities Act of
1933, as amended, for which a pricing service is unable to provide a market
price; securities whose trading has been formally suspended; a security whose
Page 21
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015
market or fair value price is not available from a pre-established pricing
source; a security with respect to which an event has occurred that is likely to
materially affect the value of the security after the market has closed but
before the calculation of the Fund's NAV or make it difficult or impossible to
obtain a reliable market quotation; and a security whose price, as provided by
the pricing service, does not reflect the security's fair value. As a general
principle, the current fair value of a security would appear to be the amount
which the owner might reasonably expect to receive for the security upon its
current sale. When fair value prices are used, generally they will differ from
market quotations or official closing prices on the applicable exchanges. A
variety of factors may be considered in determining the fair value of such
securities, including, but not limited to, the following:
1) the type of security;
2) the size of the holding;
3) the initial cost of the security;
4) transactions in comparable securities;
5) price quotes from dealers and/or pricing services;
6) relationships among various securities;
7) information obtained by contacting the issuer, analysts, or the
appropriate stock exchange;
8) an analysis of the issuer's financial statements; and
9) the existence of merger proposals or tender offers that might affect
the value of the security.
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 methodologies 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 October 31, 2015, is
included with the Fund's Portfolio of Investments.
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.
Dividend income is recorded on the ex-dividend date.
Distributions received from the Fund's investments in real estate investment
trusts ("REITs") may be comprised of return of capital, capital gains and
income. The actual character of the amounts received during the year are not
known until after the REIT's fiscal year end. The Fund records the character of
distributions received from the REITs during the year based on estimates
available. The characterization of distributions received by the Fund may be
subsequently revised based on information received from the REITs after their
tax reporting periods conclude.
C. SHORT SALES
Short sales are utilized for investment and risk management purposes and are
transactions in which securities or other instruments (such as options forwards,
futures or other derivative contracts) are sold that are not currently owned in
the Fund's portfolio. When the Fund engages in a short sale, the Fund must
borrow the security sold short and deliver the security to the counterparty.
Short selling allows the Fund to profit from a decline in a market price to the
extent such decline exceeds the transaction costs and the costs of borrowing the
securities. The Fund will pay a fee or premium to borrow the securities and is
obligated to repay the lenders of the securities. Any dividends or interest that
accrues on the securities during the period of the loan are due to the lenders.
A gain, limited to the price at which the security was sold short, or a loss,
unlimited in size, will be recognized upon the termination of the short sale;
Page 22
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015
which is effected by the Fund purchasing the security sold short in the market
and delivering the security to the lender. Any such gain or loss may be offset,
completely or in part, by the change in the value of the long portion of the
Fund's portfolio. The Fund is subject to the risk that it may be unable to
reacquire a security to terminate a short position except at a price
substantially in excess of the last quoted price. Also, there is the risk that
the counterparty to a short sale may fail to honor its contractual terms,
causing a loss to the Fund. The Fund has established an account with Pershing,
LLC for the purpose of purchasing securities on margin. The Fund pays interest
on any margin balance, which is calculated as the daily margin account balance
times the broker's margin interest rate. Restricted cash in the amount of
$9,245,221, as shown on the Statement of Assets and Liabilities, is associated
with collateral at the broker as of October 31, 2015.
D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income, if any, are declared and paid quarterly,
or as the Board of Trustees may determine from time to time. Distributions of
net realized capital gains earned by the Fund, if any, will be distributed at
least annually.
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 net asset value
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 time in the future. Permanent differences
incurred during the year ended October 31, 2015, resulting in book and tax
accounting differences, have been reclassified at year end to reflect a decrease
in accumulated net investment income (loss) by $3,211, a decrease in accumulated
net realized gain (loss) on investments by $376,283 and an increase in
paid-in-capital by $379,494. Net assets were not affected by this
reclassification.
The tax character of distributions paid during the fiscal year ended October 31,
2015 and fiscal period ended October 31, 2014 was as follows:
Distributions paid from: 2015 2014
Ordinary income.................................... $ 64,116 $ 1,620
As of October 31, 2015, the components of distributable earnings on a tax basis
to the Fund were as follows:
Undistributed ordinary income...................... $ --
Accumulated capital and other losses............... (90,580)
Net unrealized appreciation (depreciation)......... 469,368
E. 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.
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. The taxable years ended 2014 and
2015 remain open to federal and state audit. As of October 31, 2015, 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.
The Fund intends to utilize provisions of the federal income tax laws, which
allow it to carry a realized capital loss forward indefinitely following the
year of the loss and offset such loss against any future realized capital gains.
The Fund is subject to certain limitations under 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. At October 31, 2015, the
Fund had non-expiring capital loss carryforwards for federal income tax purposes
of $90,580.
Certain losses realized during the current fiscal year may be deferred and
treated as occurring on the first day of the following fiscal year for federal
income tax purposes. For the fiscal year ended October 31, 2015, the Fund had no
net ordinary losses.
Page 23
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015
In order to present paid-in capital, accumulated net investment income (loss)
and accumulated net realized gain (loss) on investments on the Statement of
Assets and Liabilities that more closely represent their tax character, certain
adjustments have been made to paid-in capital, accumulated net investment income
(loss) and accumulated net realized gain (loss) on investments. These
adjustments are primarily due to the difference between book and tax treatments
of income and gains on various investment securities held by the Fund and
in-kind transactions. The results of operations and net assets were not affected
by these adjustments.
F. EXPENSES
Expenses, other than the investment advisory fee, dividend expenses on
investments sold short and other excluded expenses, are paid by the Advisor (See
Note 3).
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 selection and ongoing monitoring of the securities
in the Fund's portfolio, managing the Fund's business affairs and providing
certain administrative services necessary for the management of the Fund.
Pursuant to the Investment Management Agreement, First Trust manages the
investment of the Fund's assets and is responsible for the Fund's expenses,
including the cost of transfer agency, custody, fund administration, legal,
audit and other services, but excluding fee payments under the Investment
Management Agreement, interest, taxes, brokerage commissions and other expenses
connected with the execution of portfolio transactions, distribution and service
fees pursuant to a 12b-1 plan, if any, acquired fund fees and expenses, dividend
expenses on investments sold short and extraordinary expenses. The Fund has
agreed to pay First Trust an annual unitary management fee equal to 0.95% of its
average daily net assets. First Trust also provides fund reporting services to
the Fund for a flat annual fee in the amount of $9,250, which is covered under
the annual unitary management fee.
The Fund has multiple service agreements with Brown Brothers Harriman & Co.
("BBH"). Under the service agreements, BBH performs custodial, fund accounting,
certain administrative services, and transfer agency services for the Fund. As
custodian, BBH is responsible for custody of the Fund's assets. As fund
accountant and administrator, BBH is responsible for maintaining the books and
records of the Fund's securities and cash. As transfer agent, BBH is responsible
for maintaining shareholder records for the Fund.
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 that is allocated pro rata among each fund in the First Trust Fund
Complex based on net assets. Each Independent Trustee is also paid an annual per
fund fee that varies based on whether the fund is a closed-end or other actively
managed fund, or is an index fund.
Additionally, the Lead Independent Trustee and the Chairmen of the Audit
Committee, Nominating and Governance Committee and Valuation Committee are paid
annual fees 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 Committee Chairmen rotate every
three years. The officers and "Interested" Trustee receive no compensation from
the Trust for acting in such capacities.
4. PURCHASES AND SALES OF SECURITIES
For the year ended October 31, 2015, the cost of purchases and proceeds from
sales of investments, excluding short-term investments and in-kind transactions,
for the Fund were $36,304,786 and $45,096,160, respectively. The cost of
purchases to cover short sales and the proceeds of short sales were $7,836,819
and $16,556,153, respectively.
For the year ended October 31, 2015, the cost of in-kind purchases and proceeds
from in-kind sales for the Fund was $33,332,729 and $4,859,907, respectively.
5. CREATIONS, REDEMPTIONS AND TRANSACTION FEES
Shares are created and redeemed by the Fund only in Creation Unit size
aggregations of 50,000 shares in transactions with broker-dealers or large
institutional investors that have entered into a participation agreement (an
"Authorized Participant"). In order to purchase Creation Units of the Fund, an
Authorized Participant must deposit (i) a designated portfolio of securities
determined by First Trust (the "Deposit Securities") and generally make or
receive a cash payment referred to as the "Cash Component," which is an amount
Page 24
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015
equal to the difference between the NAV of the Fund shares (per Creation Unit
aggregations) and the market value of the Deposit Securities, and/or (ii) cash
in lieu of all or a portion of the Deposit Securities. If the Cash Component is
a positive number (i.e., the NAV per Creation Unit Aggregation exceeds the
Deposit Amount), the Authorized Participant will deliver the Cash Component. If
the Cash Component is a negative number (i.e., the NAV per Creation Unit
Aggregation is less than the Deposit Amount), the Authorized Participant will
receive the Cash Component. Purchasers of Creation Units must pay to BBH, as
transfer agent, a creation fee (the "Creation Transaction Fee") regardless of
the number of Creation Units purchased in the transaction. The Creation
Transaction Fee may vary and is based on the composition of the securities
included in the Fund's portfolio and the countries in which the transactions are
settled. The Creation Transaction Fee may increase or decrease as the Fund's
portfolio is adjusted to conform to changes in the composition of the securities
included in the Fund's portfolio and the countries in which the transaction
settled. The Creation Transaction fee is currently $550. The price for each
Creation Unit will equal the daily NAV per share times the number of shares in a
Creation Unit plus the fees described above and, if applicable, any operational
processing and brokerage costs, transfer fees or stamp taxes. When the Fund
permits an Authorized Participant to substitute cash or a different security in
lieu of depositing one or more of the requisite Deposit Securities, the
Authorized Participant may also be assessed an amount to cover the cost of
purchasing the Deposit Securities and/or disposing of the substituted
securities, including operational processing and brokerage costs, transfer fees,
stamp taxes, and part or all of the spread between the expected bid and offer
side of the market related to such Deposit Securities and/or substitute
securities.
Authorized Participants redeeming Creation Units must pay to BBH, as transfer
agent, a redemption transaction fee (the "Redemption Transaction Fee"),
regardless of the number of Creation Units redeemed in the transaction. The
Redemption Transaction Fee may vary and is based on the composition of the
securities included in the Fund's portfolio and the countries in which the
transactions are settled. The Redemption Transaction Fee is currently $550. The
Fund reserves the right to effect redemptions in cash. An Authorized Participant
may request cash redemption in lieu of securities; however, the Fund may, in its
discretion, reject any such request.
6. DISTRIBUTION PLAN
The Board of Trustees adopted a Distribution and Service Plan pursuant to Rule
12b-1 under the 1940 Act. In accordance with the Rule 12b-1 plan, the Fund is
authorized to pay an amount up to 0.25% of its average daily net assets each
year to reimburse FTP, the distributor of the Fund, for amounts expended to
finance activities primarily intended to result in the sale of Creation Units or
the provision of investor services. FTP may also use this amount to compensate
securities dealers or other persons that are Authorized Participants for
providing distribution assistance, including broker-dealer and shareholder
support and educational and promotional services.
No 12b-1 fees are currently paid by the Fund, and pursuant to a contractual
arrangement, no 12b-1 fees will be paid any time before August 26, 2016.
7. INDEMNIFICATION
The Trust, on behalf of the Fund, has a variety of indemnification obligations
under contracts with its service providers. The Trust's maximum exposure under
these arrangements is unknown. However, the Trust has not had prior claims or
losses pursuant to these contracts and expects the risk of loss to be remote.
8. ADOPTION OF NON-FUNDAMENTAL INVESTMENT POLICY
On March 27, 2015, the Board of Trustees of the Trust approved the adoption of a
non-fundamental investment policy regarding the Fund's ability to invest in
other investment companies (the "Policy"). Pursuant to the Policy, beginning on
June 7, 2015, the Fund no longer relies on Section 12(2)(1)(F) or Section
12(d)(1)(G) of the 1940 Act to invest in other investment companies.
9. 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 there was the
following subsequent event:
At a meeting on December 7, 2015, the Board accepted Mr. Bradley's resignation
from his position as the President and Chief Executive Officer of the Trust,
effective December 31, 2015. At the same meeting, the Board elected Mr. Dykas to
serve as the President and Chief Executive Officer and Mr. Donald Swade,
formerly an Assistant Treasurer of the Trust, to serve as the Treasurer, Chief
Financial Officer and Chief Accounting Officer of the Trust.
Page 25
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------------------------------
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST LONG/SHORT EQUITY ETF:
We have audited the accompanying statement of assets and liabilities of First
Trust Long/Short Equity ETF (the "Fund"), a series of the First Trust
Exchange-Traded Fund III, including the portfolio of investments, as of October
31, 2015, and the related statement of operations for the year then ended, and
the statements of changes in net assets and the financial highlights for each of
the periods presented. These financial statements and financial highlights are
the responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of October 31, 2015 by correspondence with the Fund's
custodian and brokers; when replies were not received from brokers, we performed
other auditing procedures. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of First
Trust Long/Short Equity ETF as of October 31, 2015, the results of its
operations for the year then ended, and the changes in its net assets and the
financial highlights for each of the periods presented, in conformity with
accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Chicago, Illinois
December 23, 2015
Page 26
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015 (UNAUDITED)
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Trust 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.
PORTFOLIO HOLDINGS
The Trust 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 Trust'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.
FEDERAL TAX INFORMATION
For the taxable year ended October 31, 2015, the following percentages of income
dividend paid by the Fund qualify for the dividends received deduction available
to corporations and is hereby designated as qualified dividend income:
Dividends Received Deduction Qualified Dividend Income
---------------------------- ----------------------------
100% 100%
RISK CONSIDERATIONS
You could lose money by investing in the Fund. An investment in the Fund is not
a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other governmental agency. There can be no
assurance that the Fund's investment objective will be achieved.
CASH TRANSACTIONS RISK. The Fund may, under certain circumstances, effect a
portion of creations and redemptions for cash, rather than in-kind securities,
particularly for the puts and call options in which the Fund invests. As a
result, an investment in the Fund may be less tax-efficient than an investment
in an ETF that effects its creations and redemption for in-kind securities.
Because the Fund may effect a portion of redemptions for cash, it may be
required to sell portfolio securities in order to obtain the cash needed to
distribute redemption proceeds. A sale of shares may result in capital gains or
losses, and may also result in higher brokerage costs.
DEPOSITARY RECEIPTS RISK. Depositary receipts may be less liquid than the
underlying shares in their primary trading market. Any distributions paid to the
holders of depositary receipts are usually subject to a fee charged by the
depositary. Holders of depositary receipts may have limited voting rights, and
investment restrictions in certain countries may adversely impact the value of
depositary receipts because such restrictions may limit the ability to convert
the equity shares into depositary receipts and vice versa. Such restrictions may
cause the equity shares of the underlying issuer to trade at a discount or
premium to the market price of the depositary receipts.
DERIVATIVES RISK. The use of futures and other derivatives can lead to losses
because of adverse movements in the price or value of the underlying asset,
index or rate, which may be magnified by certain features of the derivatives.
These risks are heightened when the Fund's portfolio managers use derivatives to
enhance the Fund's return or as a substitute for a position or security, rather
than solely to hedge (or offset) the risk of a position or security held by the
Fund.
EQUITY SECURITIES RISK. The Fund invests in Equity Securities. The value of the
shares will fluctuate with changes in the value of these Equity Securities.
Equity Securities prices fluctuate for several reasons, including changes in
investors' perceptions of the financial condition of an issuer or the general
condition of the relevant stock market, such as the current market volatility,
or when political or economic events affecting the issuers occur. In addition,
common stock prices may be particularly sensitive to rising interest rates, as
the cost of the capital rises and borrowing costs increase.
ETF RISK. The Fund may invest in the shares of other ETFs, and therefore, the
Fund's investment performance and risks may be related to the investment
performance and risks of the underlying ETFs. In general, as a shareholder in
other ETFs, the Fund bears its ratable share of the underlying ETF's expenses,
and would be subject to duplicative expenses to the extent the Fund invests in
other ETFs.
Page 27
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015 (UNAUDITED)
MANAGEMENT RISK. The Fund is subject to management risk because it is an
actively managed portfolio. In managing the Fund's investment portfolio, the
Fund's investment advisor will apply investment techniques and risk analyses
that may not have the desired result. There can be no guarantee that the Fund
will meet its investment objective.
MARKET RISK. Market risk is the risk that a particular security owned by the
Fund or shares of the Fund in general may fall in value. Securities are subject
to market fluctuations caused by such factors as economic, political, regulatory
or market developments, changes in interest rates and perceived trends in
securities prices. Overall securities values could decline generally or could
underperform other investments.
NEW FUND RISK. The Fund currently has fewer assets than larger funds, and like
other relatively new funds, large inflows and outflows may impact the Fund's
market exposure for limited periods of time. This impact may be positive or
negative, depending on the direction of market movement during the period
affected. Also, during the initial invest-up period, the Fund may depart from
its principal investment strategies and invest a larger amount or all of its
assets in cash equivalents or it may hold cash.
NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the
Investment Company Act of 1940, as amended (the "1940 Act"). As a result, the
Fund is only limited as to the percentage of its assets that may be invested in
the securities of any one issuer by the diversification requirements imposed by
the Internal Revenue Code of 1986, as amended (the "Code"). The Fund may invest
a relatively high percentage of its assets in a limited number of issuers. As a
result, the Fund may be more susceptible to a single adverse economic or
regulatory occurrence affecting one or more of these issuers, experience
increased volatility and be highly invested in certain issuers.
NON-U.S. SECURITIES RISK. The Fund holds non-U.S. securities that are either
directly listed on a U.S. securities exchange or in the form of depositary
receipts. Non-U.S. securities are subject to higher volatility than securities
of domestic issuers due to possible adverse political, social or economic
developments; restrictions on foreign investment or exchange of securities; lack
of liquidity; currency exchange rates; excessive taxation; government seizure of
assets; different legal or accounting standards; and less government supervision
and regulation of exchanges in foreign countries.
SHORT SALES RISK. The Fund will incur a loss as a result of a short sale if the
price of the security sold short increases in value between the date of the
short sale and the date on which the Fund purchases the security to replace the
borrowed security. In addition, a lender of a security may request, or market
conditions may dictate, that securities sold short be returned to the lender on
short notice, which may result in the Fund having to buy the securities sold
short at an unfavorable price. If this occurs, any anticipated gain to the Fund
may be reduced or eliminated or the short sale may result in a loss. In a rising
stock market, the Fund's short positions may significantly impact the Fund's
overall performance and cause the Fund to underperform traditional long-only
equity funds or to sustain losses, particularly in a sharply rising market. The
use of short sales may also cause the Fund to have higher expenses than other
funds.
Page 28
--------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015 (UNAUDITED)
The Trust's statement of additional information includes additional information
about the Trustees and is available, without charge, upon request, by calling
(800) 988-5891.
NUMBER OF OTHER
PORTFOLIOS IN TRUSTEESHIPS OR
TERM OF OFFICE THE FIRST TRUST DIRECTORSHIPS
NAME, ADDRESS, AND YEAR FIRST FUND COMPLEX HELD BY TRUSTEE
DATE OF BIRTH AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING PAST
POSITION WITH THE TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
------------------------------------------------------------------------------------------------------------------------------------
Richard E. Erickson, Trustee o Indefinite Term Physician; President, Wheaton Orthopedics; 117 None
c/o First Trust Advisors L.P. Limited Partner, Gundersen Real Estate
120 East Liberty Drive, o Since Inception Limited Partnership; Member, Sportsmed
Suite 400 LLC
Wheaton, IL 60187
D.O.B.: 04/51
Thomas R. Kadlec, Trustee o Indefinite Term President (March 2010 to Present), Senior 117 Director of ADM
c/o First Trust Advisors L.P. Vice President and Chief Financial Officer Investor Services,
120 East Liberty Drive, o Since Inception (May 2007 to March 2010), ADM Investor Inc., ADM
Suite 400 Services, Inc. (Futures Commission Investor Services
Wheaton, IL 60187 Merchant) International and
D.O.B.: 11/57 Futures Industry
Association
Robert F. Keith, Trustee o Indefinite Term President (2003 to Present), Hibs 117 Director of Trust
c/o First Trust Advisors L.P. Enterprises (Financial and Management Company of
120 East Liberty Drive, o Since Inception Consulting) Illinois
Suite 400
Wheaton, IL 60187
D.O.B.: 11/56
Niel B. Nielson, Trustee o Indefinite Term Managing Director and Chief Operating 117 Director of
c/o First Trust Advisors L.P. Officer (January 2015 to Present), Pelita Covenant
120 East Liberty Drive, o Since Inception Harapan Educational Foundation Transport, Inc.
Suite 400 (Educational Products and Services); (May 2003 to
Wheaton, IL 60187 President and Chief Executive Officer May 2014)
D.O.B.: 03/54 (June 2012 to September 2014), Servant
Interactive LLC (Educational Products and
Services); President and Chief Executive
Officer (June 2012 to September 2014), Dew
Learning LLC (Educational Products and
Services); President (June 2002 to
June 2012), Covenant College
------------------------------------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
James A. Bowen(1), Trustee, o Indefinite Term Chief Executive Officer (December 2010 to 117 None
Chairman of the Board Present), President (until December 2010),
120 East Liberty Drive, o Since Inception First Trust Advisors L.P. and First Trust
Suite 400 Portfolios L.P.; Chairman of the Board of
Wheaton, IL 60187 Directors, BondWave LLC (Software
D.O.B.: 09/55 Development Company/Investment Advisor
and Stonebridge Advisors LLC (Investment
Advisor)
-----------------------------
(1) Mr. Bowen is deemed an "interested person" of the Trust due to his
position as Chief Executive Officer of First Trust Advisors L.P.,
investment advisor of the Trust.
Page 29
--------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015 (UNAUDITED)
POSITION AND TERM OF OFFICE
NAME, ADDRESS OFFICES AND LENGTH OF PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH TRUST SERVICE DURING PAST 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES(2)
------------------------------------------------------------------------------------------------------------------------------------
Mark R. Bradley President and Chief o Indefinite Term Chief Operating Officer (December 2010 to Present)
120 E. Liberty Drive, Executive Officer and Chief Financial Officer, First Trust Advisors
Suite 400 o Since Inception L.P. and First Trust Portfolios L.P.; Chief Financial
Wheaton, IL 60187 Officer, BondWave LLC (Software Development
D.O.B.: 11/57 Company/Investment Advisor) and Stonebridge
Advisors LLC (Investment Advisor)
James M. Dykas Treasurer, Chief Financial o Indefinite Term Controller (January 2011 to Present), Senior Vice
120 E. Liberty Drive, Officer and Chief President (April 2007 to Present), First Trust
Suite 400 Accounting Officer o Since Inception Advisors L.P. and First Trust Portfolios L.P.
Wheaton, IL 60187
D.O.B.: 01/66
W. Scott Jardine Secretary and Chief o Indefinite Term General Counsel, First Trust Advisors L.P., First
120 E. Liberty Drive, Legal Officer Trust Portfolios L.P.; Secretary, BondWave LLC
Suite 400 o Since Inception (Software Development Company/Investment
Wheaton, IL 60187 Advisor) and Stonebridge Advisors LLC
D.O.B.: 05/60 (Investment Advisor)
Daniel J. Lindquist Vice President o Indefinite Term Managing Director (July 2012 to Present), Senior
120 E. Liberty Drive, Vice President (September 2005 to July 2012),
Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios
Wheaton, IL 60187 L.P.
D.O.B.: 02/70
Kristi A. Maher Chief Compliance Officer o Indefinite Term Deputy General Counsel, First Trust Advisors
120 E. Liberty Drive, and Assistant Secretary L.P. and First Trust Portfolios L.P.
Suite 400 o Since Inception
Wheaton, IL 60187
D.O.B.: 12/66
Roger F. Testin Vice President o Indefinite Term Senior Vice President, First Trust Advisors L.P.
120 E. Liberty Drive, and First Trust Portfolios L.P.
Suite 400 o Since Inception
Wheaton, IL 60187
D.O.B.: 06/66
Stan Ueland Vice President o Indefinite Term Senior Vice President (September 2012 to Present),
120 E. Liberty Drive, Vice President (August 2005 to September 2012),
Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios
Wheaton, IL 60187 L.P.
D.O.B.: 11/70
-----------------------------
(2) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 30
--------------------------------------------------------------------------------
PRIVACY POLICY
--------------------------------------------------------------------------------
FIRST TRUST LONG/SHORT EQUITY ETF (FTLS)
OCTOBER 31, 2015 (UNAUDITED)
PRIVACY POLICY
First Trust values our relationship with you and considers your privacy an
important priority in maintaining that relationship. We are committed to
protecting the security and confidentiality of your personal information.
SOURCES OF INFORMATION
We collect nonpublic personal information about you from the following sources:
o Information we receive from you and your broker-dealer, investment
advisor or financial representative through interviews,
applications, agreements or other forms;
o Information about your transactions with us, our affiliates or
others;
o Information we receive from your inquiries by mail, e-mail or
telephone; and
o Information we collect on our website through the use of "cookies".
For example, we may identify the pages on our website that your
browser requests or visits.
INFORMATION COLLECTED
The type of data we collect may include your name, address, social security
number, age, financial status, assets, income, tax information, retirement and
estate plan information, transaction history, account balance, payment history,
investment objectives, marital status, family relationships and other personal
information.
DISCLOSURE OF INFORMATION
We do not disclose any nonpublic personal information about our customers or
former customers to anyone, except as permitted by law. In addition to using
this information to verify your identity (as required under law), the permitted
uses may also include the disclosure of such information to unaffiliated
companies for the following reasons:
o In order to provide you with products and services and to effect
transactions that you request or authorize, we may disclose your
personal information as described above to unaffiliated financial
service providers and other companies that perform administrative or
other services on our behalf, such as transfer agents, custodians
and trustees, or that assist us in the distribution of investor
materials such as trustees, banks, financial representatives, proxy
services, solicitors and printers.
o We may release information we have about you if you direct us to do
so, if we are compelled by law to do so, or in other legally limited
circumstances (for example to protect your account from fraud).
In addition, in order to alert you to our other financial products and services,
we may share your personal information with affiliates of the Fund.
PRIVACY ONLINE
We allow third-party companies, including AddThis (a social media sharing
service), to collect certain anonymous information when you visit our website.
These companies may use non-personally identifiable information during your
visits to this and other websites in order to provide advertisements about goods
and services likely to be of greater interest to you. These companies typically
use a cookie, third party web beacon or pixel tags, to collect this information.
To learn more about this behavioral advertising practice, you can visit
www.networkadvertising.org.
CONFIDENTIALITY AND SECURITY
With regard to our internal security procedures, we restrict access to your
nonpublic personal information to those individuals who need to know that
information to provide products or services to you. We maintain physical,
electronic and procedural safeguards to protect your nonpublic personal
information.
POLICY UPDATES AND INQUIRIES
As required by federal law, we will notify you of our privacy policy annually.
We reserve the right to modify this policy at any time, however, if we do change
it, we will tell you promptly. For questions about our policy, or for additional
copies of this notice, please go to www.ftportfolios.com, or contact us at
1-800-621-1675 (First Trust Portfolios) or 1-800-222-6822 (First Trust
Advisors).
Page 31
This page intentionally left blank.
FIRST TRUST
First Trust Exchange-Traded Fund III
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
ADMINISTRATOR, CUSTODIAN,
FUND ACCOUNTANT &
TRANSFER AGENT
Brown Brothers Harriman & Co.
50 Post Office Square
Boston, MA 02110
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]
FIRST TRUST
First Trust Exchange-Traded Fund III
------------------------------------
First Trust Emerging Markets Local Currency Bond ETF (FEMB)
Annual Report
For the Period
November 4, 2014
(Commencement of Operations)
through October 31, 2015
--------------------------------------------------------------------------------
TABLE OF CONTENTS
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
ANNUAL REPORT
OCTOBER 31, 2015
Shareholder Letter......................................................... 1
Fund Performance Overview.................................................. 2
Portfolio Commentary....................................................... 5
Understanding Your Fund Expenses........................................... 7
Portfolio of Investments................................................... 8
Statement of Assets and Liabilities........................................ 12
Statement of Operations.................................................... 13
Statement of Changes in Net Assets......................................... 14
Financial Highlights....................................................... 15
Notes to Financial Statements.............................................. 16
Report of Independent Registered Public Accounting Firm ................... 23
Additional Information .................................................... 24
Board of Trustees and Officers ............................................ 26
Privacy Policy ............................................................ 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") or First Trust Global Portfolios Ltd. (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
the series of First Trust Exchange-Traded Fund III (the "Trust") described in
this report for the First Trust Emerging Markets Local Currency Bond ETF
(hereinafter referred to as 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 objective. 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 Additional
Information section of this report 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 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 in
the Fund. It includes details about the Fund's portfolio 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 the
Advisor 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 material risks of investing in the
Fund are spelled out in its prospectus, statement of additional information,
this report and other Fund regulatory filings.
--------------------------------------------------------------------------------
SHAREHOLDER LETTER
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
ANNUAL LETTER FROM THE CHAIRMAN AND CEO
OCTOBER 31, 2015
Dear Shareholders:
Thank you for your investment in First Trust Emerging Markets Local Currency
Bond ETF (the "Fund").
First Trust Advisors L.P. ("First Trust") is pleased to provide you with the
annual report which contains detailed information about your investment for the
annual investment period ended October 31, 2015, including a market overview and
a performance analysis for the period. We encourage you to read this report and
discuss it with your financial advisor.
U.S. markets, fueled by accelerating growth and an accommodating Federal
Reserve, enjoyed a prosperous year in 2014. However, most of 2015 has been
volatile. Economic and global factors, such as the continued conflict in the
Middle East, a sharp decline in oil prices and terrorism around the world, have
impacted U.S. and global markets. Another factor that has weighed upon U.S.
markets for most of the year is the fact that many economists had predicted that
the Federal Reserve would begin to raise interest rates in 2015, which has still
not happened.
As I have written previously, First Trust believes investors should maintain
perspective about the markets and have realistic expectations about their
investments. Markets will always go up and down, but we believe that having a
long-term investment horizon and being invested in quality products can help you
reach your goals.
Thank you for giving First Trust the opportunity to be a part of your investment
plan. We value the relationship and will continue to focus on our disciplined
investment approach and long-term perspective to help investors reach their
financial goals.
Sincerely,
/s/ James A. Bowen
James A. Bowen
Chairman of the Board of Trustees
Chief Executive Officer of First Trust Advisors L.P.
Page 1
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
First Trust Emerging Markets Local Currency Bond ETF (the "Fund") seeks maximum
total return and current income. The Fund lists and principally trades its
shares on The NASDAQ Stock Market LLC ("NASDAQ") under the ticker symbol "FEMB."
Under normal market conditions, the Fund seeks to achieve its investment
objective by investing at least 80% of its net assets (including investment
borrowings) in bonds, notes and bills issued or guaranteed by entities in
emerging market countries (collectively, "Bonds") that are denominated in the
local currency of the issuer.
In implementing the Fund's investment strategy, First Trust Global Portfolios
Ltd. (the "Sub-Advisor") will seek to provide current income and enhance
capital, while minimizing volatility. The Sub-Advisor will continually review
fundamental economic and structural themes that impact long and medium term
asset returns in emerging markets. The Sub-Advisor will also consider
shorter-term market drivers such as valuations, liquidity conditions and
sentiment to determine the appropriate positioning of the Fund's investments.
The Sub-Advisor will adjust the portfolio's country allocations, duration and
individual security positioning to reflect what the Sub-Advisor believes to be
the most attractive opportunities on a continuous basis.
The Fund may invest in foreign currencies and derivative instruments, including
exchange-listed futures contracts, exchange-listed options, exchange-listed
options on futures contracts, forward currency contracts, non-deliverable
forward currency contracts and exchange-listed currency options. The Fund will
use foreign currencies and derivative instruments primarily to hedge interest
rate risk and actively manage interest rate exposure and to hedge foreign
currency risk and actively manage foreign currency exposure. The Fund may also
use derivative instruments to enhance returns, as a substitue for, or to gain
exposure to, a position in an underlying asset, to reduce transaction costs, to
maintain full market exposure, to manage cash flows or to preserve capital.
--------------------------------------------------------------------------------------------------------
PERFORMANCE
--------------------------------------------------------------------------------------------------------
CUMULATIVE
TOTAL RETURNS
Inception (11/4/14)
to 10/31/15
FUND PERFORMANCE
NAV -14.83%
Market Price -14.44%
INDEX PERFORMANCE
Barclays Emerging Markets Local Currency Government - 10% Country Capped Index -13.66%
--------------------------------------------------------------------------------------------------------
Total returns for the period since inception are calculated from the inception
date of the Fund. "Cumulative total returns" represent the total change in value
of an investment over the period indicated.
The Fund's per share net asset value ("NAV") is the value of one share of the
Fund and is computed by dividing the value of all assets of the Fund (including
accrued interest and dividends), less all liabilities (including accrued
expenses and dividends declared but unpaid), by the total number of outstanding
shares. The price used to calculate market return ("Market Price") is determined
by using the midpoint between the highest bid and the lowest offer on the stock
exchange on which shares of the Fund are listed for trading as of the time that
the Fund's NAV is calculated. Since shares of the Fund did not trade in the
secondary market until after its inception, for the period from inception to the
first day of secondary market trading in shares of the Fund, the NAV of the Fund
is used as a proxy for the secondary market trading price to calculate market
returns. NAV and market returns assume that all distributions have been
reinvested in the Fund at NAV and Market Price, respectively.
An index is a statistical composite that tracks a specified financial market or
sector. Unlike the Fund, the index does not actually hold a portfolio of
securities and therefore does not incur the expenses incurred by the Fund. These
expenses negatively impact the performance of the Fund. Also, market returns do
not include brokerage commissions that may be payable on secondary market
transactions. If brokerage commissions were included, market returns would be
lower. The total returns presented reflect the reinvestment of dividends on
securities in the index. The returns presented do not reflect the deduction of
taxes that a shareholder would pay on Fund distributions or the redemption or
sale of Fund shares. The investment return and principal value of shares of the
Fund will vary with changes in market conditions. Shares of the Fund may be
worth more or less than their original cost when they are redeemed or sold in
the market. The Fund's past performance is no guarantee of future performance.
Page 2
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
----------------------------------------------------------------
SECTOR ALLOCATION AS OF OCTOBER 31, 2015
----------------------------------------------------------------
% OF TOTAL
SECTOR INVESTMENTS
Sovereigns 85.3%
Supranationals 9.8
Central Bank 4.9
-------
Total 100.0%
=======
----------------------------------------------------------------
CREDIT QUALITY AS OF OCTOBER 31, 2015
----------------------------------------------------------------
% OF TOTAL
INVESTMENTS
CREDIT RATING(1) (INCLUDING CASH)
AAA 9.3%
AA 14.4
A+ 4.5
A 18.0
A- 5.6
BBB+ 8.4
BBB 13.5
BBB- 21.0
Cash 5.3
-------
Total 100.0%
=======
----------------------------------------------------------------
TOP 10 HOLDINGS AS OF OCTOBER 31, 2015
----------------------------------------------------------------
% OF TOTAL
TOP 10 HOLDINGS INVESTMENTS
Czech Republic Government Bond,
2.40%, 9/17/25 10.3%
Brazil Notas do Tesouro Nacional,
Series F, 10.00%, 1/1/21 6.6
Poland Government Bond, 5.50%, 10/25/19 6.1
Philippine Government International
Bond, 3.90%, 11/26/22 5.5
Indonesia Treasury Bond, 8.38%, 3/15/24 5.1
Romania Government Bond, 5.85%, 4/26/23 5.0
Bonos del Banco Central de Chile en
Pesos, 6.00%, 2/1/21 4.9
Thailand Government Bond, 3.63%, 6/16/23 4.8
Hungary Government Bond, 6.50%, 6/24/19 4.8
Israel Government Bond - Fixed, 6.25%,
10/30/26 4.8
-------
Total 57.9%
=======
(1) The credit quality and ratings information presented above reflect 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
creditworthiness of the issuers of the underlying securities in the Fund,
and not to the Fund or its shares. Credit ratings are subject to change.
Page 3
--------------------------------------------------------------------------------
FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
PERFORMANCE OF A $10,000 INITIAL INVESTMENT
NOVEMBER 4, 2014 - OCTOBER 31, 2015
First Trust Emerging Barclays Emerging Markets Local
Markets Local Currency Government - 10%
Currency Bond ETF Country Capped Index
11/4/14 $10,000 $10,000
4/30/15 9,340 9,450
10/31/15 8,517 8,634
Performance figures assume reinvestment of all distributions and do not reflect
the deduction of taxes that a shareholder would pay on Fund distributions or the
redemption or sale of Fund shares. An index is a statistical composite that
tracks a specified financial market or sector. Unlike the Fund, the index does
not actually hold a portfolio of securities and therefore does not incur the
expenses incurred by the Fund. These expenses negatively impact the performance
of the Fund. The Fund's past performance does not predict future performance.
FREQUENCY DISTRIBUTION OF DISCOUNTS AND PREMIUMS
BID/ASK MIDPOINT VS. NAV THROUGH OCTOBER 31, 2015
The following Frequency Distribution of Discounts and Premiums charts are
provided to show the frequency at which the bid/ask midpoint price for the Fund
was at a discount or premium to the daily NAV. The following tables are for
comparative purposes only and represent the period November 5, 2014
(commencement of trading) through October 31, 2015. Shareholders may pay more
than NAV when they buy Fund shares and receive less than NAV when they sell
those shares because shares are bought and sold at current market price. Data
presented represents past performance and cannot be used to predict future
results.
------------------------------------------------------------------------------
NUMBER OF DAYS BID/ASK MIDPOINT AT/ABOVE NAV
------------------------------------------------------------------------------
FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00%
11/5/14 - 10/31/15 116 110 7 1
------------------------------------------------------------------------------
NUMBER OF DAYS BID/ASK MIDPOINT BELOW NAV
------------------------------------------------------------------------------
FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00%
11/5/14 - 10/31/15 15 0 0 1
Page 4
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
ANNUAL REPORT
OCTOBER 31, 2015
INVESTMENT ADVISOR
First Trust Advisors L.P. ("First Trust" or the "Advisor"), 120 East Liberty
Drive, Wheaton, Illinois 60187, is the investment advisor to the Fund. First
Trust Global Portfolios Ltd. ("FTGP"), an affiliate of First Trust, serves as
investment sub-advisor to the Fund.
INVESTMENT SUB-ADVISOR
FTGP acts as a sub-advisor of the Fund and is headed by Derek Fulton, Director,
Chief Executive Officer and Chief Investment Officer of FTGP. Mr. Fulton has
been managing global portfolios with a focus on fixed income for over 15 years.
Prior to joining FTGP in 2011, he co-founded ISIS Asset Management ("ISIS AM")
and led its investment team. Before starting ISIS AM, he was Head of Global &
Closed-End Fixed Income Portfolios at Aberdeen Asset Management ("Aberdeen") in
London and also held positions as Head of Asian Fixed Income based in Singapore.
At Aberdeen, Mr. Fulton oversaw in excess of $10 billion of assets including
institutional global government and global aggregate accounts. He was also a
member of the currency team running active currency overlays on over $20 billion
of institutional mandates.
PORTFOLIO MANAGEMENT TEAM
The following portfolio managers are primarily responsible for the day-to-day
management of the Fund. Each portfolio manager has managed the Fund since 2014.
DEREK FULTON, CHIEF EXECUTIVE OFFICER AND CHIEF INVESTMENT OFFICER, FTGP
LEONARDO DA COSTA, PORTFOLIO MANAGER, FTGP
COMMENTARY
MARKET RECAP
The last 12 months can be characterized by currency weakness and higher yields
across most emerging markets. The weakness was primarily concentrated in the
current account deficit and commodity producing countries. Two major catalysts
for this weakness came from the concern over the timing of an interest rate hike
by the U.S. Federal Reserve and slowing growth across the major emerging
nations, particularly China.
The U.S Federal Reserve indicated for most of the year it would soon consider an
interest rate hike, as the unemployment level in the U.S dropped towards 5%.
This raised fears among emerging market investors that as soon as the Federal
Reserve raised interest rates, capital would flow out of these countries,
especially as many emerging markets were maintaining easy monetary policy to
boost growth domestically. The net effect was that emerging market currencies
weakened against the U.S dollar. Currency weakness has a negative impact on
local asset prices for international investors, however, over the medium to
longer term, the weaker currencies also help these emerging economies realign
their external accounts by making their imports more expensive and their exports
cheaper.
As highlighted above, the weaker growth outlook for many emerging markets, in
particular China, also weighed on investors sentiment culminating in the Chinese
authorities' decision to allow the weakening of the Chinese Yuan versus the U.S
dollar in August. Although the Yuan was only 3% weaker, at its worst, the
immediate response was this was an attempt by China to steal export market share
from its Asian counterparts and in doing so to encourage more currency weakness.
This premise, however, fell apart as the Yuan was swiftly brought under control
and a more likely reason for the currency adjustment, in our view, is that
Chinese authorities are well aware that they cannot maintain easy monetary
policy and fairly free capital flows without allowing some flexibility in the
Yuan. This scare for Chinese growth led to both the U.S Federal Reserve and the
European Central Bank citing emerging market growth risks as concerns for their
monetary policy decisions, seemingly hurting risk assets further.
In addition, a few specific geopolitical events in some key emerging market
countries led to increased volatility, particularly in those markets. The
surprise downgrade of Brazilian debt by Standard & Poor's and the inconclusive
election results in Turkey elevated concerns about the ability of those
governments to manage these events in an environment of slowing economic growth.
The other casualty of the weaker outlook for Chinese growth was commodity
prices. Oil prices dropped precipitously, closely followed by copper and iron
ore prices. This spread the economic weakness from China to the rest of the
commodity exporting emerging market nations.
Page 5
--------------------------------------------------------------------------------
PORTFOLIO COMMENTARY (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
ANNUAL REPORT
OCTOBER 31, 2015
PERFORMANCE ANALYSIS
As the Fund's annual investment period ended October 31, 2015, the Fund returned
-14.83% on a net asset value ("NAV") basis since its inception on November 4,
2014. The market price return was -14.44% over the same period. The Barclays
Emerging Markets Local Currency Government - 10% Country Capped Index returned
-13.66%, over the same period. While the Fund was defensively positioned through
most of the year, it still suffered, as the weakness in the asset class became
quite generalized. The Fund avoided exposure to some of the commodity-reliant
countries such as Russia and had underweight holdings in other commodity
exporters, as these credits suffered disproportionately more on the weaker
growth outlook and weak commodity prices.
The Fund also effectively hedged some of the currency exposure in the portfolio,
as the pressure from the strong U.S dollar led to currency weakness. Allocations
instead were concentrated in commodity, particularly oil, importers that benefit
from weaker commodity prices as well as those countries that could capitalize on
neighboring developed markets that were either growing or stimulating
aggressively (for example, Mexico, Poland and the Czech Republic).
MARKET AND FUND OUTLOOK
Emerging markets are characteristically vulnerable to shocks stemming from
political turmoil, global growth and commodity cycles as well as increased risk
aversion. Managing through this volatility and continuing to select undervalued
opportunities should enable the Fund to provide attractive returns over time.
In our opinion, strong fundamentals including lower debt levels and higher
growth rates will once again reassert themselves and attract investors to the
asset class for the yields on offer. Valuation indicators for a broad swath of
emerging market yield curves and currencies are enticingly cheap, with most at
multi-year lows. We also expect to see continued differentiation between those
credits that will benefit from their weaker currencies and the lower commodity
price environment. We have witnessed a number of countries that have used lower
energy prices to make energy-related reforms more palatable to their voters and
the weaker currencies to adjust their trade and current accounts balances. As we
receive more clarity on the impact of the U.S Federal Reserve interest rate
hiking cycle, we believe these fundamentally stable and improving credits should
be key beneficiaries of any resurgence in investor flows to the asset class.
Page 6
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
UNDERSTANDING YOUR FUND EXPENSES
OCTOBER 31, 2015 (UNAUDITED)
As a shareholder of First Trust Emerging Markets Local Currency Bond ETF (the
"Fund") you incur two types of costs: (1) transaction costs; and (2) ongoing
costs, including management fees, distribution and/or service fees, if any, and
other Fund expenses. This Example is intended to help you understand your
ongoing costs of investing in the Fund and to compare these costs with the
ongoing costs of investing in other funds.
The Example is based on an investment of $1,000 invested at the beginning of the
period and held through the six-month period ended October 31, 2015.
ACTUAL EXPENSES
The first line in the following table provides information about actual account
values and actual expenses. You may use the information in this line, together
with the amount you invested, to estimate the expenses that you paid over the
period. Simply divide your account value by $1,000 (for example, an $8,600
account value divided by $1,000 = 8.6), then multiply the result by the number
in the first line under the heading entitled "Expenses Paid During the Six-Month
Period" to estimate the expenses you paid on your account during this six-month
period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line in the following table provides information about hypothetical
account values and hypothetical expenses based on the Fund's actual expense
ratio and an assumed rate of return of 5% per year before expenses, which is not
the Fund's actual return. The hypothetical account values and expenses may not
be used to estimate the actual ending account balance or expenses you paid for
the period. You may use this information to compare the ongoing costs of
investing in the Fund and other funds. To do so, compare this 5% hypothetical
example with the 5% hypothetical examples that appear in the shareholder reports
of the other funds.
Please note that the expenses shown in the table are meant to highlight your
ongoing costs only and do not reflect any transactional costs such as brokerage
commissions. Therefore, the second line in the table is useful in comparing
ongoing costs only, and will not help you determine the relative total costs of
owning different funds. In addition, if these transactional costs were included,
your costs would have been higher.
-------------------------------------------------------------------------------------------------------------------------
ANNUALIZED
EXPENSE RATIO EXPENSES PAID
BEGINNING ENDING BASED ON THE DURING THE
ACCOUNT VALUE ACCOUNT VALUE SIX-MONTH SIX-MONTH
MAY 1, 2015 OCTOBER 31, 2015 PERIOD PERIOD (a)
-------------------------------------------------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
Actual $1,000.00 $ 911.90 0.85% $4.10
Hypothetical (5% return before expenses) $1,000.00 $1,020.92 0.85% $4.33
(a) Expenses are equal to the annualized expense ratio as indicated in the
table multiplied by the average account value over the period (May 1, 2015
through October 31, 2015), multiplied by 184/365.
Page 7
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 2015
PRINCIPAL
VALUE
(LOCAL STATED STATED VALUE
CURRENCY) DESCRIPTION COUPON MATURITY (US DOLLARS)
------------- ----------------------------------------------------------------- ------------- ---------- ------------
FOREIGN SOVEREIGN BONDS AND NOTES - 84.7%
BRAZIL - 9.0%
600,000 Brazil Notas do Tesouro Nacional, Series F (BRL)................. 10.00% 01/01/25 $ 114,165
1,200,000 Brazil Notas do Tesouro Nacional, Series F (BRL)................. 10.00% 01/01/21 251,854
------------
366,019
------------
CHILE - 4.6%
120,000,000 Bonos del Banco Central de Chile en Pesos (CLP).................. 6.00% 02/01/21 187,977
------------
COLOMBIA - 3.8%
457,000,000 Colombian TES (COP).............................................. 7.00% 05/04/22 155,039
------------
CZECH REPUBLIC - 9.7%
8,190,000 Czech Republic Government Bond (CZK)............................. 2.40% 09/17/25 394,658
------------
HUNGARY - 4.5%
45,000,000 Hungary Government Bond (HUF).................................... 6.50% 06/24/19 182,477
------------
INDONESIA - 7.4%
2,720,000,000 Indonesia Treasury Bond (IDR).................................... 8.38% 03/15/24 194,316
1,500,000,000 Indonesia Treasury Bond (IDR).................................... 7.88% 04/15/19 106,812
------------
301,128
------------
ISRAEL - 4.4%
500,000 Israel Government Bond - Fixed (ILS)............................. 6.25% 10/30/26 182,262
------------
MEXICO - 8.3%
2,340,000 Mexican Bonos (MXN).............................................. 7.75% 05/29/31 159,573
2,290,000 Mexican Bonos (MXN).............................................. 10.00% 12/05/24 177,806
------------
337,379
------------
PERU - 1.0%
125,000 Peru Government Bond (PEN)....................................... 7.84% 08/12/20 40,984
------------
PHILIPPINES - 5.2%
10,000,000 Philippine Government International Bond (PHP)................... 3.90% 11/26/22 211,667
------------
POLAND - 9.6%
545,000 Poland Government Bond (PLN)..................................... 4.00% 10/25/23 155,672
800,000 Poland Government Bond (PLN)..................................... 5.50% 10/25/19 235,424
------------
391,096
------------
ROMANIA - 4.7%
650,000 Romania Government Bond (RON).................................... 5.85% 04/26/23 190,611
------------
SOUTH AFRICA - 4.5%
1,600,000 South Africa Government Bond (ZAR)............................... 6.25% 03/31/36 86,654
1,180,000 South Africa Government Bond (ZAR)............................... 10.50% 12/21/26 98,495
------------
185,149
------------
THAILAND - 4.5%
6,100,000 Thailand Government Bond (THB)................................... 3.63% 06/16/23 183,202
------------
TURKEY - 3.5%
410,000 Turkey Government Bond (TRY)..................................... 10.50% 01/15/20 144,922
------------
TOTAL FOREIGN SOVEREIGN BONDS AND NOTES..................................................... 3,454,570
(Cost $4,008,119) ------------
Page 8 See Notes to Financial Statements
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
PRINCIPAL
VALUE
(LOCAL STATED STATED VALUE
CURRENCY) DESCRIPTION COUPON MATURITY (US DOLLARS)
------------- ----------------------------------------------------------------- ------------- ---------- ------------
FOREIGN CORPORATE BONDS AND NOTES - 9.3%
SUPRANATIONALS - 9.3%
270,000 International Finance Corp. (BRL)................................ 10.00% 06/12/17 $ 67,903
10,000,000 European Bank for Reconstruction & Development (INR)............. 6.00% 03/03/16 152,953
1,200,000 European Investment Bank (ZAR)................................... 6.00% 10/21/19 81,603
1,200,000 Inter-American Development Bank (MXN)............................ 8.00% 01/26/16 73,771
------------
TOTAL FOREIGN CORPORATE BONDS AND NOTES..................................................... 376,230
(Cost $461,052) ------------
TOTAL INVESTMENTS - 94.0%................................................................... 3,830,800
(Cost $4,469,171) (a)
NET OTHER ASSETS AND LIABILITIES - 6.0%..................................................... 246,642
------------
NET ASSETS - 100.0%......................................................................... $ 4,077,442
============
------------------------------
(a) Aggregate cost for federal income tax purposes is $4,469,171. As of
October 31, 2015, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was $13,821
and the aggregate gross unrealized depreciation for all securities in
which there was an excess of tax cost over value was $652,192.
Currency Abbreviations:
BRL Brazilian Real
CLP Chilean Peso
COP Colombian Peso
CZK Czech Republic Koruna
HUF Hungarian Forint
IDR Indonesian Rupiah
ILS Israel Shekel
INR Indian Rupee
MXN Mexican Peso
PEN Peruvian New Sol
PHP Philippines Peso
PLN Polish Zloty
RON Romanian Lev
THB Thailand Baht
TRY Turkish Lira
USD United States Dollar
ZAR South African Rand
See Notes to Financial Statements Page 9
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
-----------------------------
VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of October 31,
2015 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
10/31/2015 PRICES INPUTS INPUTS
------------- ------------- -------------- --------------
Foreign Sovereign Bonds and Notes*................. $ 3,454,570 $ -- $ 3,454,570 $ --
Foreign Corporate Bonds and Notes*................. 376,230 -- 376,230 --
------------- ------------- -------------- --------------
Total Investments.................................. 3,830,800 -- 3,830,800 --
Forward Foreign Currency Contracts**............... 2,266 -- 2,266 --
------------- ------------- -------------- --------------
Total.............................................. $ 3,833,066 $ -- $ 3,833,066 $ --
============= ============= ============== ==============
* See the Portfolio of Investments for country breakout.
** See the Forward Foreign Currency Contracts table for contract and currency
detail.
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 October 31, 2015.
Page 10 See Notes to Financial Statements
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
PORTFOLIO OF INVESTMENTS (CONTINUED)
OCTOBER 31, 2015
--------------------------------------------
% OF TOTAL
CURRENCY EXPOSURE INVESTMENTS
DIVERSIFICATION (INCLUDING CASH)+
--------------------------------------------
BRL 10.7%
MXN 10.2
CZK 9.8
PLN 9.7
IDR 7.5
ZAR 6.6
ILS 5.4
PHP 5.2
RON 4.7
CLP 4.6
THB 4.5
HUF 4.5
USD 4.4
COP 3.8
INR 3.8
TRY 3.6
PEN 1.0
-------
Total 100.0%
=======
+ The weightings include the impact of currency forwards.
FORWARD FOREIGN CURRENCY CONTRACTS (see Note 2C - Forward Foreign Currency
Contracts in the Notes to Financial Statements):
FORWARD FOREIGN CURRENCY CONTRACTS
---------------------------------------------------
PURCHASE SALE UNREALIZED
SETTLEMENT AMOUNT AMOUNT VALUE AS OF VALUE AS OF APPRECIATION/
DATE COUNTERPARTY PURCHASED (1) SOLD (1) OCTOBER 31, 2015 OCTOBER 31, 2015 (DEPRECIATION)
-------------- -------------- -------------- --------------- ---------------- ---------------- ---------------
11/30/15 BBH USD 206,263 MXN 3,400,000 $ 206,263 $ 205,418 $ 845
11/30/15 BBH USD 69,749 ZAR 950,000 69,749 68,328 1,421
---------------
Net Unrealized Appreciation (Depreciation)................................................................ $ 2,266
===============
(1) Please see Portfolio of Investments for currency descriptions.
Counterparty Abbreviations:
BBH Brown Brothers Harriman & Co.
See Notes to Financial Statements Page 11
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 2015
ASSETS:
Investments, at value.................................................. $ 3,830,800
Cash................................................................... 178,425
Foreign currency....................................................... 35,225
Unrealized appreciation on forward foreign currency contracts.......... 2,266
Receivables:
Investment securities sold.......................................... 148,733
Interest............................................................ 68,846
-----------------
Total Assets........................................................ 4,264,295
-----------------
LIABILITIES:
Payables:
Investment securities purchased..................................... 183,891
Investment advisory fees............................................ 2,962
-----------------
Total Liabilities................................................... 186,853
-----------------
NET ASSETS............................................................. $ 4,077,442
=================
NET ASSETS CONSIST OF:
Paid-in capital........................................................ $ 4,768,288
Par value.............................................................. 1,000
Accumulated net investment income (loss)............................... (4,151)
Accumulated net realized gain (loss) on investments, forward foreign
currency contracts and foreign currency transactions................ (50,063)
Net unrealized appreciation (depreciation) on investments, forward
foreign currency contracts and foreign currency translation......... (637,632)
-----------------
NET ASSETS............................................................. $ 4,077,442
=================
NET ASSET VALUE, per share............................................. $ 40.77
=================
Number of shares outstanding (unlimited number of shares authorized,
par value $0.01 per share).......................................... 100,002
=================
Investments, at cost................................................... $ 4,469,171
=================
Foreign currency, at cost (proceeds)................................... $ 35,288
=================
Page 12 See Notes to Financial Statements
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
STATEMENT OF OPERATIONS
FOR THE PERIOD NOVEMBER 4, 2014 (a) THROUGH OCTOBER 31, 2015
INVESTMENT INCOME:
Interest............................................................... $ 237,129
Foreign tax withholding................................................ (5,496)
-----------------
Total investment income............................................. 231,633
-----------------
EXPENSES:
Investment advisory fees............................................... 37,778
-----------------
Total expenses...................................................... 37,778
-----------------
NET INVESTMENT INCOME (LOSS)........................................... 193,855
-----------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on:
Investments......................................................... (260,243)
Forward foreign currency contracts.................................. (6,305)
Foreign currency transactions....................................... (25,899)
-----------------
Net realized gain (loss)............................................... (292,447)
-----------------
Net change in unrealized appreciation (depreciation) on:
Investments......................................................... (638,371)
Forward foreign currency contracts.................................. 2,266
Foreign currency translation........................................ (1,527)
-----------------
Net change in unrealized appreciation (depreciation)................... (637,632)
-----------------
NET REALIZED AND UNREALIZED GAIN (LOSS)................................ (930,079)
-----------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING
FROM OPERATIONS..................................................... $ (736,224)
=================
(a) Inception date is November 4, 2014, which is consistent with the
commencement of investment operations and is the date the initial creation
units were established.
See Notes to Financial Statements Page 13
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
STATEMENT OF CHANGES IN NET ASSETS
FOR THE PERIOD NOVEMBER 4, 2014 (a) THROUGH OCTOBER 31, 2015
OPERATIONS:
Net investment income (loss)........................................... $ 193,855
Net realized gain (loss)............................................... (292,447)
Net change in unrealized appreciation (depreciation)................... (637,632)
-----------------
Net increase (decrease) in net assets resulting from operations........ (736,224)
-----------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Return of capital...................................................... (194,434)
-----------------
Total distributions to shareholders.................................... (194,434)
-----------------
SHAREHOLDER TRANSACTIONS:
Proceeds from shares sold.............................................. 5,008,100
Cost of shares redeemed................................................ --
-----------------
Net increase (decrease) in net assets resulting from shareholder
transactions........................................................ 5,008,100
-----------------
Total increase (decrease) in net assets................................ 4,077,442
NET ASSETS:
Beginning of period.................................................... --
-----------------
End of period.......................................................... $ 4,077,442
=================
Accumulated net investment income (loss) at end of year................ $ (4,151)
=================
CHANGES IN SHARES OUTSTANDING:
Shares outstanding, beginning of period................................ --
Shares sold............................................................ 100,002
-----------------
Shares outstanding, end of period...................................... 100,002
=================
(a) Inception date is November 4, 2014, which is consistent with the
commencement of investment operations and is the date the initial creation
units were established.
Page 14 See Notes to Financial Statements
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
FOR THE PERIOD
11/4/2014 (a)
THROUGH
10/31/2015
--------------
Net asset value, beginning of period $ 50.00
----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) 1.94
Net realized and unrealized gain (loss) (9.23)
----------
Total from investment operations (7.29)
----------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Return of capital (1.94)
----------
Total distributions (1.94)
----------
Net asset value, end of period $ 40.77
==========
TOTAL RETURN (b) (14.83)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 4,077
Ratio of total expenses to average net assets 0.85% (c)
Ratio of net investment income (loss) to
average net assets 4.36% (c)
Portfolio turnover rate (d) 49%
(a) Inception date is consistent with the commencement of investment
operations and is the date the initial creation units were established.
(b) Total return is calculated assuming an initial investment made at the net
asset value at the beginning of the period, reinvestment of all
distributions at net asset value during the period, and redemption at net
asset value on the last day of the period. The return presented does not
reflect the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption or sale of Fund shares. Total return is
calculated for the time period presented and is not annualized for periods
of less than a year.
(c) Annualized.
(d) Portfolio turnover is calculated for the time period presented and is not
annualized for periods of less than a year and does not include securities
received or delivered from processing creations or redemptions and in-kind
transactions.
See Notes to Financial Statements Page 15
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015
1. ORGANIZATION
First Trust Exchange-Traded Fund III (the "Trust") is a non-diversified open-end
management investment company organized as a Massachusetts business trust on
January 9, 2008, and is registered with the Securities and Exchange Commission
under the Investment Company Act of 1940, as amended (the "1940 Act").
The Trust currently consists of four funds that are offering shares. This report
covers the First Trust Emerging Markets Local Currency Bond ETF (the "Fund"),
which trades under the ticker FEMB on The NASDAQ(R) Stock Market LLC ("NASDAQ").
Unlike conventional mutual funds, the Fund issues and redeems shares on a
continuous basis, at net asset value ("NAV"), only in large specified blocks
consisting of 50,000 shares called a "Creation Unit." Creation Units are issued
and redeemed for securities in which the Fund invests or for cash or, in certain
circumstances, a combination of both. Except when aggregated in Creation Units,
the shares are not redeemable securities of the Fund.
The Fund is an actively managed exchange-traded fund. The investment objective
of the Fund is to seek maximum total return and current income. Under normal
market conditions, the Fund seeks to achieve its investment objective by
investing at least 80% of its net assets (including investment borrowings) in
bonds, notes, bills, certificates of deposit, time deposits, commercial paper
and loans issued by issuers in emerging market countries that are denominated in
the local currency of the issuer. The Fund may not be appropriate for all
investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The Fund, which is an investment company within the scope of Financial
Accounting Standards Board ("FASB") Accounting Standards Update 2013-08, follows
accounting and reporting guidance under FASB Accounting Standards Codification
Topic 946, "Financial Services-Investment Companies." The following is a summary
of significant accounting policies consistently followed by the Fund in the
preparation of the 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 Fund's NAV is determined daily as of the close of regular trading on The New
York Stock Exchange ("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
Fund's 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 Fund's NAV is calculated by dividing the value
of all assets of the Fund (including accrued interest and dividends), less all
liabilities (including accrued expenses and dividends declared but unpaid), by
the total number of shares outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value. Market
value prices represent last sale or official closing prices from a national or
foreign exchange (i.e., a regulated market) and are primarily obtained from
third-party pricing services. Fair value prices represent any prices not
considered market value prices and are either obtained from a third-party
pricing service or are determined by the Pricing Committee of the Fund's
investment advisor, First Trust Advisors L.P. ("First Trust" or the "Advisor"),
in accordance with valuation procedures adopted by the Trust's Board of
Trustees, and in accordance with provisions of the 1940 Act. Investments valued
by the Advisor's Pricing Committee, if any, are footnoted as such in the
footnotes to the Portfolio of Investments. The Fund's investments are valued as
follows:
Bonds, notes and other debt securities are fair valued on the basis of
valuations provided by dealers who make markets in such securities or by
an independent pricing service approved by the Trust'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.
Page 16
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015
Fixed income and other debt securities having a remaining maturity of 60
days or less when purchased are fair valued at cost adjusted for
amortization of premiums and accretion of discounts (amortized cost),
provided the Advisor's Pricing Committee has determined that the use of
amortized cost is an appropriate reflection of fair value given market and
issuer-specific conditions existing at the time of the determination.
Factors that may be considered in determining the appropriateness of the
use of amortized cost include, but are not limited to, the following:
1) the credit conditions in the relevant market and changes thereto;
2) the liquidity conditions in the relevant market and changes thereto;
3) the interest rate conditions in the relevant market and changes
thereto (such as significant changes in interest rates);
4) issuer-specific conditions (such as significant credit
deterioration); and
5) any other market-based data the Advisor's Pricing Committee
considers relevant. In this regard, the Advisor's Pricing Committee
may use last-obtained market-based data to assist it when valuing
portfolio securities using amortized cost.
Forward foreign currency contracts are fair valued at the current day's
interpolated foreign exchange rate, as calculated using the current day's
spot rate, and the thirty, sixty, ninety, and one-hundred eighty day
forward rates provided by an independent pricing service.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Trust's Board of Trustees or its
delegate, the Advisor's Pricing Committee, at fair value. These securities
generally include, but are not limited to, restricted securities (securities
which may not be publicly sold without registration under the Securities Act of
1933, as amended) for which a pricing service is unable to provide a market
price; securities whose trading has been formally suspended; a security whose
market or fair value price is not available from a pre-established pricing
source; a security with respect to which an event has occurred that is likely to
materially affect the value of the security after the market has closed but
before the calculation of the Fund's NAV or make it difficult or impossible to
obtain a reliable market quotation; and a security whose price, as provided by
the pricing service, does not reflect the security's fair value. As a general
principle, the current fair value of a security would appear to be the amount
which the owner might reasonably expect to receive for the security upon its
current sale. When fair value prices are used, generally they will differ from
market quotations or official closing prices on the applicable exchanges. A
variety of factors may be considered in determining the fair value of such
securities, including, but not limited to, the following:
1) the fundamental business data relating to the issuer, or economic
data relating to the country of issue;
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 security;
4) the financial statements of the issuer, or the financial condition
of the country of issue;
5) the credit quality and cash flow of the issuer, or country of issue,
based on the 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 (for corporate debt only);
11) the economic, political and social prospects/developments of the
country of issue and the assessment of the country's governmental
leaders/officials (for sovereign debt only);
12) the prospects for the issuer's industry, and multiples (of earnings
and/or cash flows) being paid for similar businesses in that
industry (for corporate debt only); and
13) other relevant factors.
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.
Page 17
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015
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 methodologies 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 October 31, 2015, is
included with the Fund's Portfolio of Investments.
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 on the accrual basis. Amortization of premiums and
accretion of discounts are recorded using the effective interest method.
C. FORWARD FOREIGN CURRENCY CONTRACTS
The Fund is subject to foreign currency risk in the normal course of pursuing
its investment objectives. Forward foreign currency contracts are agreements
between two parties ("Counterparties") to exchange one currency for another at a
future date and at a specified price. The Fund uses forward foreign currency
contracts to facilitate transactions in foreign securities and to manage the
Fund's foreign currency exposure. These contracts are valued daily, and the
Fund's net equity therein, representing unrealized gain or loss on the contracts
as measured by the difference between the forward foreign exchange rates at the
dates of entry into the contracts and the forward rates at the reporting date,
is included in "Unrealized appreciation (depreciation) on forward foreign
currency contracts" on the Statement of Assets and Liabilities. The change in
unrealized appreciation (depreciation) is included in "Net change in unrealized
appreciation (depreciation) on forward foreign currency contracts" on the
Statement of Operations. When the forward contract is closed, the Fund records a
realized gain or loss equal to the difference between the proceeds from (or the
cost of) the closing transaction and the Fund's basis in the contract. This
realized gain or loss is included in "Net realized gain (loss) on forward
foreign currency contracts" on the Statement of Operations. Risks arise from the
possible inability of counterparties to meet the terms of their contracts and
from movement in currency, securities values and interest rates. Due to the
risks, the Fund could incur losses in excess of the net unrealized value shown
on the Forward Foreign Currency Contracts table in the Portfolio of Investments.
In the event of default by the Counterparty, the Fund will provide notice to the
Counterparty of the Fund's intent to convert the currency held by the Fund into
the currency that the Counterparty agreed to exchange with the Fund. If a
Counterparty becomes bankrupt or otherwise fails to perform its obligations due
to financial difficulties, the Fund may experience significant delays in
obtaining any recovery in a bankruptcy or other reorganization proceeding. The
Fund may obtain only limited recovery or may obtain no recovery in such
circumstances.
D. OFFSETTING ON THE STATEMENT OF ASSETS AND LIABILITIES
Offsetting Assets and Liabilities require entities to disclose both gross and
net information about instruments and transactions eligible for offset on the
Statement of Assets and Liabilities, and disclose instruments and transactions
subject to master netting or similar agreements. These disclosure requirements
are intended to help investors and other financial statement users better assess
the effect or potential effect of offsetting arrangements on a fund's financial
position. The transactions subject to offsetting disclosures are derivative
instruments, repurchase agreements and reverse repurchase agreements, and
securities borrowing and securities lending transactions.
For financial reporting purposes, the Fund does not offset financial assets and
financial liabilities that are subject to master netting arrangements ("MNAs")
or similar agreements on the Statement of Assets and Liabilities. MNAs provide
the right, in the event of default (including bankruptcy and insolvency), for
the non-defaulting counterparty to liquidate the collateral and calculate the
net exposure to the defaulting party or request additional collateral.
Page 18
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015
At October 31, 2015, derivative assets and liabilities (by type) on a gross
basis are as follows:
Gross Amounts not Offset in
the Statement of Assets
and Liabilities
---------------------------
Gross Amounts Net Amounts of Assets
Offset in the Presented in the Collateral
Gross Amounts of Statement of Assets Statement of Assets Financial Amounts
Recognized Assets and Liabilities and Liabilities Instruments Received Net Amount
----------------------------------------------------------------------------------------------------------------------------------
Forward Foreign Currency
Contracts* $ 2,266 $ -- $ 2,266 $ -- $ -- $ 2,266
* The respective counterparties for each contract are disclosed on the
Forward Foreign Currency Contracts table in the Portfolio of Investments.
E. FOREIGN CURRENCY
The books and records of the Fund are maintained in U.S. dollars. Foreign
currencies, investments and other assets and liabilities are translated into
U.S. dollars at the exchange rates prevailing at the end of the period.
Purchases and sales of investments and items of income and expense are
translated on the respective dates of such transactions. Unrealized gains and
losses on assets and liabilities, other than investments in securities, which
result from changes in foreign currency exchange rates have been included in
"Net change in unrealized appreciation (depreciation) on foreign currency
translation" on the Statement of Operations. Unrealized gains and losses on
investments in securities which result from changes in foreign exchange rates
are included with fluctuations arising from changes in market price and are
shown in "Net change in unrealized appreciation (depreciation) on investments"
on the Statement of Operations. Net realized foreign currency gains and losses
include the effect of changes in exchange rates between trade date and
settlement date on investment security transactions, foreign currency
transactions and interest and dividends received. The portion of foreign
currency gains and losses related to fluctuations in exchange rates between the
initial purchase settlement date and subsequent sale trade date is included in
"Net realized gain (loss) on investments" on the Statement of Operations.
F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS
Dividends from net investment income, if any, are declared and paid monthly, or
as the Board of Trustees may determine from time to time. Distributions of net
realized capital gains earned by the Fund, if any, will be distributed at least
annually.
Distributions from net investment income and realized 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 net asset value 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 time in the
future.
The tax character of distributions paid during the fiscal period ended October
31, 2015 was as follows:
Distributions paid from:
Ordinary income.............................................. $ --
Capital gain................................................. --
Return of capital............................................ 194,434
As of October 31, 2015, the components of distributable earnings on a tax basis
were as follows:
Undistributed ordinary income................................ $ --
Accumulated capital and other losses......................... (50,063)
Net unrealized appreciation (depreciation)................... (641,783)
G. INCOME TAXES
The Fund intends 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 and 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.
Page 19
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015
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. The taxable year ended 2015
remains open to federal and state audit. As of October 31, 2015, 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.
The Fund intends to utilize provisions of the federal income tax laws, which
allow it to carry a realized capital loss forward indefinitely following the
year of the loss and offset such loss against any future realized capital gains.
The Fund is subject to certain limitations under U.S. tax rules on the use of
capital carryforwards and net unrealized built-in losses. These limitations
apply when there has been a 50% change in ownership. At October 31, 2015, the
Fund had non-expiring capital loss carryforwards for federal income tax purposes
of $50,063.
Certain losses realized during the current fiscal year may be deferred and
treated as occurring on the first day of the following fiscal year for federal
income tax purposes. For the fiscal period ended October 31, 2015, the Fund had
no net ordinary losses.
In order to present paid-in capital, accumulated net investment income (loss)
and accumulated net realized gain (loss) on investments on the Statement of
Assets and Liabilities that more closely represent their tax character, certain
adjustments have been made to paid-in capital, accumulated net investment income
(loss) and accumulated net realized gain (loss) on investments. These
adjustments are primarily due to the difference between book and tax treatments
of income and gains on various investment securities held by the Fund and
in-kind transactions. The results of operations and net assets were not affected
by these adjustments. For the fiscal year ended October 31, 2015, the
adjustments for the Fund were as follows:
Accumulated
Accumulated Net Realized
Net Investment Gain (Loss) Paid-in
Income (Loss) on Investments Capital
--------------- --------------- -------------
$ (198,006) $ 242,384 $ (44,378)
H. EXPENSES
Expenses, other than the investment advisory fee and other excluded expenses,
are paid by the Advisor (See Note 3).
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 selection and ongoing monitoring of the securities
in the Fund's portfolio, managing the Fund's business affairs and providing
certain administrative services necessary for the management of the Fund.
The Trust, on behalf of the Fund, and First Trust have retained First Trust
Global Portfolios Ltd. ("First Trust Global" or the "Sub- Advisor"), an
affiliate of First Trust, to serve as investment sub-advisor. In this capacity,
First Trust Global is responsible for the selection and ongoing monitoring of
the securities in the Fund's investment portfolio. First Trust is paid an annual
unitary management fee of 0.85% of the Fund's average daily net assets. First
Trust Global receives a sub-advisory fee equal to 40% of any remaining monthly
unitary fee paid to the Advisor after the Fund's average expenses accrued during
the most recent twelve months are subtracted from the unitary fee for that
month. First Trust is responsible for the expenses of the Fund including the
cost of transfer agency, custody, fund administration, legal, audit and other
services, and excluding Rule 12b-1 distribution and service fees, if any,
brokerage expenses, taxes, interest, acquired fund fees and expenses and
extraordinary expenses. First Trust also provides fund reporting services to the
Fund for a flat annual fee in the amount of $9,250, which is covered under the
annual unitary management fee.
The Trust has multiple service agreements with Brown Brothers Harriman & Co.
("BBH"). Under the service agreements, BBH performs custodial, fund accounting,
certain administrative services, and transfer agency services for the Fund. As
custodian, BBH is responsible for custody of the Fund's assets. As fund
accountant and administrator, BBH is responsible for maintaining the books and
records of the Fund's securities and cash. As transfer agent, BBH is responsible
for maintaining shareholder records for the Fund.
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 that is allocated pro rata among each fund in the First Trust Fund
Complex based on net assets. Each Independent Trustee is also paid an annual per
fund fee that varies based on whether the fund is a closed-end or other actively
managed fund, or is an index fund.
Page 20
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015
Additionally, the Lead Independent Trustee and the Chairmen of the Audit
Committee, Nominating and Governance Committee and Valuation Committee are paid
annual fees 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 Committee Chairmen rotate every
three years. The officers and "Interested" Trustee receive no compensation from
the Trust for acting in such capacities.
4. PURCHASES AND SALES OF SECURITIES
For the period ended October 31, 2015, the cost of purchases and proceeds from
sales of investments, excluding short-term investments and in-kind transactions,
for the Fund were $6,779,517 and $2,012,695, respectively.
For the period ended October 31, 2015, the Fund had no in-kind transactions.
5. DERIVATIVE TRANSACTIONS
The following table presents the type of derivative held by the Fund at October
31, 2015, the primary underlying risk exposure and location of these instruments
as presented on the Statement of Assets and Liabilities.
ASSET DERIVATIVES LIABILITY DERIVATIVES
------------------------------------------- -------------------------------------------
DERIVATIVE STATEMENT OF ASSETS AND STATEMENT OF ASSETS AND
INSTRUMENT RISK EXPOSURE LIABILITIES LOCATION FAIR VALUE LIABILITIES LOCATION FAIR VALUE
------------------ -------------- ------------------------ ---------------- ------------------------ ----------------
Unrealized appreciation Unrealized depreciation
Forward foreign on forward foreign on forward foreign
currency contracts Currency Risk currency contracts $ 2,266 currency contracts $ --
The following table presents the amount of net realized gain (loss) and change
in net unrealized appreciation (depreciation) recognized for the period ended
October 31, 2015, on derivative instruments, as well as the primary underlying
risk exposure associated with each instrument.
STATEMENT OF OPERATIONS LOCATION
------------------------------------------------------------------------------
CURRENCY RISK
Net realized gain (loss) on forward foreign currency contracts $ (6,305)
Net change in unrealized appreciation (depreciation) on forward
foreign currency contracts 2,266
During the period ended October 31, 2015, the notional values of forward foreign
currency contracts opened and closed were $8,340,884 and $7,344,754,
respectively.
6. CREATIONS, REDEMPTIONS AND TRANSACTION FEES
Shares are created and redeemed by the Fund only in Creation Unit size
aggregations of 50,000 shares in transactions with broker-dealers or large
institutional investors that have entered into a participation agreement (an
"Authorized Participant"). In order to purchase Creation Units of the Fund, an
Authorized Participant must deposit (i) a designated portfolio of securities and
other instruments determined by First Trust (the "Deposit Securities") and
generally make or receive a cash payment referred to as the "Cash Component,"
which is an amount equal to the difference between the NAV of the Fund shares
(per Creation Unit aggregations) and the market value of the Deposit Securities,
and/or (ii) cash in lieu of all or a portion of the Deposit Securities. If the
Cash Component is a positive number (i.e., the NAV per Creation Unit Aggregation
exceeds the Deposit Amount), the Authorized Participant will deliver the Cash
Component. If the Cash Component is a negative number (i.e., the NAV per
Creation Unit Aggregation is less than the Deposit Amount), the Authorized
Participant will receive the Cash Component. Purchasers of Creation Units must
pay to BBH, as transfer agent, a creation fee (the "Creation Transaction Fee")
regardless of the number of Creation Units purchased in the transaction. The
Creation Transaction Fee may vary and is based on the composition of the
securities included in the Fund's portfolio and the countries in which the
transactions are settled. The Creation Transaction Fee may increase or decrease
as the Fund's portfolio is adjusted to conform to changes in the composition of
the securities included in the Fund's portfolio and the countries in which the
transaction settled. The Creation Transaction Fee is currently $500. The price
for each Creation Unit will equal the daily NAV per share times the number of
shares in a Creation Unit plus the fees described above and, if applicable, any
operational processing and brokerage costs, transfer fees or stamp taxes. When
the Fund permits an Authorized Participant to substitute cash or a different
security in lieu of depositing one or more of the requisite Deposit Securities,
Page 21
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015
the Authorized Participant may also be assessed an amount to cover the cost of
purchasing the Deposit Securities and/or disposing of the substituted
securities, including operational processing and brokerage costs, transfer fees,
stamp taxes, and part or all of the spread between the expected bid and offer
side of the market related to such Deposit Securities and/or substitute
securities.
Authorized Participants redeeming Creation Units must pay to BBH, as transfer
agent, a redemption transaction fee (the "Redemption Transaction Fee"),
regardless of the number of Creation Units redeemed in the transaction. The
Redemption Transaction Fee may vary and is based on the composition of the
securities included in the Fund's portfolio and the countries in which the
transactions are settled. The Redemption Transaction Fee is currently $500. The
Fund reserves the right to effect redemptions in cash. An Authorized Participant
may request cash redemption in lieu of securities; however, the Fund may, in its
discretion, reject any such request.
7. LINE OF CREDIT
Effective March 26, 2015, the Fund was added to an $80 million Credit Agreement
with the Bank of Nova Scotia ("Scotia") as administrative agent for a group of
lenders. The Credit Agreement is to be used as a liquidity backstop during
periods of high redemption volume. A commitment fee of 0.15% of the daily amount
of the excess of the commitment amount over the outstanding principal balance of
the loans is charged by Scotia, which First Trust allocates amongst the funds
that have access to the credit line. To the extent that the Fund accesses the
credit line, there would also be an interest fee charged. The Fund did not have
any borrowings outstanding during the period ended October 31, 2015.
8. DISTRIBUTION PLAN
The Board of Trustees adopted a Distribution and Service Plan pursuant to Rule
12b-1 under the 1940 Act. In accordance with the Rule 12b-1 plan, the Fund is
authorized to pay an amount up to 0.25% of its average daily net assets each
year to reimburse FTP, the distributor of the Fund, for amounts expended to
finance activities primarily intended to result in the sale of Creation Units or
to provide investor services. FTP may also use this amount to compensate
securities dealers or other persons that are Authorized Participants for
providing distribution assistance, including broker-dealer and shareholder
support and educational and promotional services.
No 12b-1 fees are currently paid by the Fund, and pursuant to a contractual
arrangement, no 12b-1 fees will be paid any time before October 10, 2016.
9. INDEMNIFICATION
The Trust, on behalf of the Fund, has a variety of indemnification obligations
under contracts with its service providers. The Trust's maximum exposure under
these arrangements is unknown. However, the Trust has not had prior claims or
losses pursuant to these contracts and expects the risk of loss to be remote.
10. ADOPTION OF NON-FUNDAMENTAL INVESTMENT POLICY
On March 27, 2015, the Board of Trustees of the Trust approved the adoption of a
non-fundamental investment policy regarding the Fund's ability to invest in
other investment companies (the "Policy"). Pursuant to the Policy, beginning on
June 7, 2015, the Fund no longer relies on Section 12(d)(1)(F) or 12(d)(1)(G) of
the 1940 Act to invest in other investment companies.
11. 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 November 19, 2015, the Fund declared a distribution of $0.1356 per share to
shareholders of record on November 24, 2015, payable November 30, 2015.
At a meeting on December 7, 2015, the Board accepted Mr. Bradley's resignation
from his position as the President and Chief Executive Officer of the Trust,
effective December 31, 2015. At the same meeting, the Board elected Mr. Dykas to
serve as the President and Chief Executive Officer and Mr. Donald Swade,
formerly an Assistant Treasurer of the Trust, to serve as the Treasurer, Chief
Financial Officer and Chief Accounting Officer of the Trust.
Page 22
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------------------------------
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST EMERGING MARKETS LOCAL
CURRENCY BOND ETF:
We have audited the accompanying statement of assets and liabilities of First
Trust Emerging Markets Local Currency Bond ETF (the "Fund"), a series of the
First Trust Exchange-Traded Fund III, including the portfolio of investments, as
of October 31, 2015, and the related statements of operations and changes in net
assets and the financial highlights for the period from November 4, 2014
(commencement of operations) through October 31, 2015. These financial
statements and financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of October 31, 2015 by correspondence with the Fund's
custodian and brokers; when replies were not received from brokers, we performed
other auditing procedures. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of First
Trust Emerging Markets Local Currency Bond ETF as of October 31, 2015, and the
results of its operations, changes in its net assets, and the financial
highlights for the period from November 4, 2014 (commencement of operations)
through October 31, 2015, in conformity with accounting principles generally
accepted in the United States of America.
/s/ Deloitte & Touche LLP
Chicago, Illinois
December 23, 2015
Page 23
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015 (UNAUDITED)
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Trust uses to determine
how to vote proxies and information on how the Fund voted proxies relating to
portfolio investments during the most recent 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.
PORTFOLIO HOLDINGS
The Trust 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 Trust's Form N-Qs
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.
FEDERAL TAX INFORMATION
Of the ordinary income (including short-term capital gain) distributions made by
the Fund during the year ended October 31, 2015, none qualify for the corporate
dividends received deduction available to corporate shareholders or as qualified
dividend income.
RISK CONSIDERATIONS
You could lose money by investing in the Fund. An investment in the Fund is not
a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency. There can be no assurance
that the investment objective will be achieved.
CALL RISK. If an issuer calls higher-yielding debt instruments held by the Fund,
performance could be adversely impacted.
CASH TRANSACTIONS RISK. The Fund will, under most circumstances, effect a
portion of creations and redemptions for cash, rather than in-kind securities.
As a result, an investment in the Fund may be less tax-efficient than an
investment in an exchange-traded fund that effects its creations and redemption
for in-kind securities. Because the Fund may effect a portion of redemptions for
cash, it may be required to sell portfolio securities in order to obtain the
cash needed to distribute redemption proceeds. A sale of shares may result in
capital gains or losses and may also result in higher brokerage costs.
CREDIT RISK. Credit risk is the risk that an issuer of a security will be unable
or unwilling to make dividend, interest and/or principal payments when due and
the related risk that the value of a security may decline because of concerns
about the issuer's ability to make such payments.
CURRENCY EXCHANGE RATE RISK. The Fund holds investments that are denominated in
non-U.S. currencies, or in securities that provide exposure to such currencies,
currency exchange rates or interest rates denominated in such currencies.
Changes in currency exchange rates and the relative value of non-U.S. currencies
will affect the value of the Fund's investment and the value of your Fund
shares. Currency exchange rates can be very volatile and can change quickly and
unpredictably. As a result, the value of an investment in the Fund may change
quickly and without warning and you may lose money.
CURRENCY RISK. Because the Fund's net asset value is determined on the basis of
U.S. dollars and the Fund invests in non-U.S. dollar-denominated securities, you
may lose money if the local currency of a foreign market depreciates against the
U.S. dollar, even if the local currency value of the Fund's holdings goes up.
The Fund may hedge certain of its non-U.S. dollar holdings.
DERIVATIVES RISK. The use of options, futures contracts, forward contracts and
other derivative instruments can lead to losses because of adverse movements in
the price or value of the underlying asset, index or rate, which may be
magnified by certain features of the derivatives. These risks are heightened
when the Fund's portfolio managers use derivatives to enhance the Fund's return
or as a substitute for a position or security, rather than solely to hedge (or
offset) the risk of a position or security held by the Fund.
EMERGING MARKETS RISK. Investments in securities and instruments traded in
developing or emerging markets or that provide exposure to such securities or
markets, can involve additional risks relating to political, economic, or
regulatory conditions not associated with investments in U.S. securities and
instruments or investments in more developed international markets. Emerging
market governments may, without prior warning, impose capital controls on the
ability to transfer currency, securities or other assets. The Fund's ability to
access certain developing or emerging markets also may be limited due to a
variety of factors, including currency convertibility issues. Such conditions
may impact the ability of the Fund to buy, sell or otherwise transfer
securities, cause the Fund's returns to differ from those available to domestic
investors, adversely affect the trading market and price for Fund shares, and
cause the Fund to decline in value.
Page 24
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015 (UNAUDITED)
GLOBAL DEPOSITARY NOTES RISK. Any distributions paid to the holders of GDNs are
usually subject to a fee charged by the depositary bank. Holders of GDNs may
have limited rights, and investment restrictions in certain countries may
adversely impact the value of GDNs because such restrictions may limit the
ability to convert the Bonds into GDNs and vice versa.
HIGH YIELD SECURITIES RISK. High yield securities, or "junk" bonds, are subject
to greater market fluctuations and risk of loss than securities with higher
ratings, and therefore, are considered to be highly speculative. These
securities are issued by issuers that may have narrowly focused operations
and/or other impediments to the timely payment of periodic interest and
principal at maturity. If the global or local economy slows down or dips into
recession, the issuers of high yield securities may not have sufficient
resources to continue making timely payment of periodic interest and principal
at maturity. The market for high yield securities is generally smaller and less
liquid than that for investment grade securities. High yield securities are
generally not listed on a national securities exchange but trade in the
over-the-counter markets.
Due to the smaller, less liquid market for high yield securities, the bid-offer
spread on such securities is generally greater than it is for investment grade
securities and the purchase or sale of such securities may take longer to
complete. In general, high yield securities may have a greater risk of default
than other types of securities.
ILLIQUID SECURITIES RISK. Some of the securities held by the Fund may be
illiquid. Illiquid securities involve the risk that the securities will not be
able to be sold at the time desired by the Fund or at prices approximately the
value at which the Fund is carrying the securities on its books.
INCOME RISK. Income from the Fund's fixed income investments could decline
during periods of falling interest rates.
INTEREST RATE RISK. Interest rate risk is the risk that the value of the fixed
income securities in the Fund will decline because of rising market interest
rates. Interest rate risk is generally lower for shorter term investments and
higher for longer term investments.
MANAGEMENT RISK. The Fund is subject to management risk because it is an
actively managed portfolio. In managing the Fund's investment portfolio, the
Fund's investment advisor will apply investment techniques and risk analyses
that may not have the desired result. There can be no guarantee that the Fund
will meet its investment objective.
MARKET RISK. Market risk is the risk that a particular security owned by the
Fund or shares of the Fund in general may fall in value. Securities are subject
to market fluctuations caused by such factors as economic, political, regulatory
or market developments, changes in interest rates and perceived trends in bond
prices. Also, certain of these factors may affect the liquidity of the Bonds in
the Fund's portfolio and make it more difficult for the Fund to sell them.
Overall securities values could decline generally or could underperform other
investments.
NEW FUND RISK. The Fund currently has fewer assets than larger funds, and like
other relatively new funds, large inflows and outflows may impact the Fund's
market exposure for limited periods of time. This impact may be positive or
negative, depending on the direction of market movement during the period
affected. Also, during the initial invest-up period, the Fund may depart from
its principal investment strategies and invest a larger amount or all of its
assets in cash equivalents or it may hold cash.
NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the
Investment Company Act of 1940, as amended (the "1940 Act"). As a result, the
Fund is only limited as to the percentage of its assets that may be invested in
the securities of any one issuer by the diversification requirements imposed by
the Internal Revenue Code of 1986, as amended. The Fund may invest a relatively
high percentage of its assets in a limited number of issuers. As a result, the
Fund may be more susceptible to a single adverse economic or regulatory
occurrence affecting one or more of these issuers, experience increased
volatility and be highly invested in certain issuers.
NON-U.S. SECURITIES RISK. Non-U.S. securities are subject to higher volatility
than securities of domestic issuers due to possible adverse political, social or
economic developments; restrictions on foreign investment or exchange of
securities; lack of liquidity; currency exchange rates; excessive taxation;
government seizure of assets; different legal or accounting standards and less
government supervision and regulation of exchanges in foreign countries.
SOVEREIGN DEBT RISK. Investments in sovereign bonds involve special risks
because the governmental authority that controls the repayment of the debt may
be unwilling or unable to repay the principal and/or interest when due in
accordance with the terms of such securities; the availability of sufficient
foreign exchange on the date a payment is due; the relative size of the debt
service burden to the economy as a whole; or the government debtor's policy
towards the International Monetary Fund and the political constraints to which a
government debtor may be subject. If an issuer of sovereign bonds defaults on
payments of principal and/or interest, the Fund may have limited legal recourse
against the issuer and/or guarantor. In certain cases, remedies must be pursued
in the courts of the defaulting party itself, and the Fund's ability to obtain
recourse may be limited. In times of economic uncertainty, the prices of these
securities may be more volatile than those of corporate debt obligations or of
other government debt obligations.
Page 25
--------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
FIRST TRUST EXCHANGE-TRADED FUND III
OCTOBER 31, 2015 (UNAUDITED)
The Trust's statement of additional information includes additional information
about the Trustees and is available, without charge, upon request, by calling
(800) 988-5891.
NUMBER OF OTHER
PORTFOLIOS IN TRUSTEESHIPS OR
TERM OF OFFICE THE FIRST TRUST DIRECTORSHIPS
NAME, ADDRESS, AND YEAR FIRST FUND COMPLEX HELD BY TRUSTEE
DATE OF BIRTH AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING PAST
POSITION WITH THE TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
------------------------------------------------------------------------------------------------------------------------------------
Richard E. Erickson, Trustee o Indefinite Term Physician; President, Wheaton Orthopedics; 117 None
c/o First Trust Advisors L.P. Limited Partner, Gundersen Real Estate
120 East Liberty Drive, o Since Inception Limited Partnership; Member, Sportsmed
Suite 400 LLC
Wheaton, IL 60187
D.O.B.: 04/51
Thomas R. Kadlec, Trustee o Indefinite Term President (March 2010 to Present), Senior 117 Director of ADM
c/o First Trust Advisors L.P. Vice President and Chief Financial Officer Investor Services,
120 East Liberty Drive, o Since Inception (May 2007 to March 2010), ADM Investor Inc., ADM
Suite 400 Services, Inc. (Futures Commission Investor Services
Wheaton, IL 60187 Merchant) International and
D.O.B.: 11/57 Futures Industry
Association
Robert F. Keith, Trustee o Indefinite Term President (2003 to Present), Hibs 117 Director of Trust
c/o First Trust Advisors L.P. Enterprises (Financial and Management Company of
120 East Liberty Drive, o Since Inception Consulting) Illinois
Suite 400
Wheaton, IL 60187
D.O.B.: 11/56
Niel B. Nielson, Trustee o Indefinite Term Managing Director and Chief Operating 117 Director of
c/o First Trust Advisors L.P. Officer (January 2015 to Present), Pelita Covenant
120 East Liberty Drive, o Since Inception Harapan Educational Foundation Transport, Inc.
Suite 400 (Educational Products and Services); (May 2003 to
Wheaton, IL 60187 President and Chief Executive Officer May 2014)
D.O.B.: 03/54 (June 2012 to September 2014), Servant
Interactive LLC (Educational Products and
Services); President and Chief Executive
Officer (June 2012 to September 2014), Dew
Learning LLC (Educational Products and
Services); President (June 2002 to
June 2012), Covenant College
------------------------------------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
James A. Bowen(1), Trustee, o Indefinite Term Chief Executive Officer (December 2010 to 117 None
Chairman of the Board Present), President (until December 2010),
120 East Liberty Drive, o Since Inception First Trust Advisors L.P. and First Trust
Suite 400 Portfolios L.P.; Chairman of the Board of
Wheaton, IL 60187 Directors, BondWave LLC (Software
D.O.B.: 09/55 Development Company/Investment Advisor
and Stonebridge Advisors LLC (Investment
Advisor)
-----------------------------
(1) Mr. Bowen is deemed an "interested person" of the Trust due to his
position as Chief Executive Officer of First Trust Advisors L.P.,
investment advisor of the Trust.
Page 26
--------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST EXCHANGE-TRADED FUND III
OCTOBER 31, 2015 (UNAUDITED)
POSITION AND TERM OF OFFICE
NAME, ADDRESS OFFICES AND LENGTH OF PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH TRUST SERVICE DURING PAST 5 YEARS
------------------------------------------------------------------------------------------------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES(2)
------------------------------------------------------------------------------------------------------------------------------------
Mark R. Bradley President and Chief o Indefinite Term Chief Operating Officer (December 2010 to Present)
120 E. Liberty Drive, Executive Officer and Chief Financial Officer, First Trust Advisors
Suite 400 o Since Inception L.P. and First Trust Portfolios L.P.; Chief Financial
Wheaton, IL 60187 Officer, BondWave LLC (Software Development
D.O.B.: 11/57 Company/Investment Advisor) and Stonebridge
Advisors LLC (Investment Advisor)
James M. Dykas Treasurer, Chief Financial o Indefinite Term Controller (January 2011 to Present), Senior Vice
120 E. Liberty Drive, Officer and Chief President (April 2007 to Present), First Trust
Suite 400 Accounting Officer o Since Inception Advisors L.P. and First Trust Portfolios L.P.
Wheaton, IL 60187
D.O.B.: 01/66
W. Scott Jardine Secretary and Chief o Indefinite Term General Counsel, First Trust Advisors L.P., First
120 E. Liberty Drive, Legal Officer Trust Portfolios L.P.; Secretary, BondWave LLC
Suite 400 o Since Inception (Software Development Company/Investment
Wheaton, IL 60187 Advisor) and Stonebridge Advisors LLC
D.O.B.: 05/60 (Investment Advisor)
Daniel J. Lindquist Vice President o Indefinite Term Managing Director (July 2012 to Present), Senior
120 E. Liberty Drive, Vice President (September 2005 to July 2012),
Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios
Wheaton, IL 60187 L.P.
D.O.B.: 02/70
Kristi A. Maher Chief Compliance Officer o Indefinite Term Deputy General Counsel, First Trust Advisors
120 E. Liberty Drive, and Assistant Secretary L.P. and First Trust Portfolios L.P.
Suite 400 o Since Inception
Wheaton, IL 60187
D.O.B.: 12/66
Roger F. Testin Vice President o Indefinite Term Senior Vice President, First Trust Advisors L.P.
120 E. Liberty Drive, and First Trust Portfolios L.P.
Suite 400 o Since Inception
Wheaton, IL 60187
D.O.B.: 06/66
Stan Ueland Vice President o Indefinite Term Senior Vice President (September 2012 to Present),
120 E. Liberty Drive, Vice President (August 2005 to September 2012),
Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios
Wheaton, IL 60187 L.P.
D.O.B.: 11/70
-----------------------------
(2) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 27
--------------------------------------------------------------------------------
PRIVACY POLICY
--------------------------------------------------------------------------------
FIRST TRUST EMERGING MARKETS LOCAL CURRENCY BOND ETF (FEMB)
OCTOBER 31, 2015 (UNAUDITED)
PRIVACY POLICY
First Trust values our relationship with you and considers your privacy an
important priority in maintaining that relationship. We are committed to
protecting the security and confidentiality of your personal information.
SOURCES OF INFORMATION
We collect nonpublic personal information about you from the following sources:
o Information we receive from you and your broker-dealer, investment
advisor or financial representative through interviews,
applications, agreements or other forms;
o Information about your transactions with us, our affiliates or
others;
o Information we receive from your inquiries by mail, e-mail or
telephone; and
o Information we collect on our website through the use of "cookies".
For example, we may identify the pages on our website that your
browser requests or visits.
INFORMATION COLLECTED
The type of data we collect may include your name, address, social security
number, age, financial status, assets, income, tax information, retirement and
estate plan information, transaction history, account balance, payment history,
investment objectives, marital status, family relationships and other personal
information.
DISCLOSURE OF INFORMATION
We do not disclose any nonpublic personal information about our customers or
former customers to anyone, except as permitted by law. In addition to using
this information to verify your identity (as required under law), the permitted
uses may also include the disclosure of such information to unaffiliated
companies for the following reasons:
o In order to provide you with products and services and to effect
transactions that you request or authorize, we may disclose your
personal information as described above to unaffiliated financial
service providers and other companies that perform administrative or
other services on our behalf, such as transfer agents, custodians
and trustees, or that assist us in the distribution of investor
materials such as trustees, banks, financial representatives, proxy
services, solicitors and printers.
o We may release information we have about you if you direct us to do
so, if we are compelled by law to do so, or in other legally limited
circumstances (for example to protect your account from fraud).
In addition, in order to alert you to our other financial products and services,
we may share your personal information within First Trust.
PRIVACY ONLINE
We allow third-party companies, including AddThis (a social media sharing
service), to collect certain anonymous information when you visit our website.
These companies may use non-personally identifiable information during your
visits to this and other websites in order to provide advertisements about goods
and services likely to be of greater interest to you. These companies typically
use a cookie, third party web beacon or pixel tags, to collect this information.
To learn more about this behavioral advertising practice, you can visit
www.networkadvertising.org.
CONFIDENTIALITY AND SECURITY
With regard to our internal security procedures, First Trust restricts access to
your nonpublic personal information to those First Trust employees who need to
know that information to provide products or services to you. We maintain
physical, electronic and procedural safeguards to protect your nonpublic
personal information.
POLICY UPDATES AND INQUIRIES
As required by federal law, we will notify you of our privacy policy annually.
We reserve the right to modify this policy at any time, however, if we do change
it, we will tell you promptly. For questions about our policy, or for additional
copies of this notice, please go to www.ftportfolios.com, or contact us at
1-800-621-1675 (First Trust Portfolios) or 1-800-222-6822 (First Trust
Advisors).
Page 28
FIRST TRUST
First Trust Exchange-Traded Fund III
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, IL 60187
ADMINISTRATOR, CUSTODIAN,
FUND ACCOUNTANT &
TRANSFER AGENT
Brown Brothers Harriman & Co.
50 Post Office Square
Boston, MA 02110
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.
(a) The registrant, as of the end of the period covered by this report, has
adopted a code of ethics that applies to the registrant's principal
executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions, regardless
of whether these individuals are employed by the registrant or a third
party.
(c) There have been no amendments, during the period covered by this report,
to a provision of the code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions,
regardless of whether these individuals are employed by the registrant or
a third party, and that relates to any element of the code of ethics
description.
(d) The registrant, during the period covered by this report, has not granted
any waivers, including an implicit waiver, from a provision of the code of
ethics that applies to the registrant's principal executive officer,
principal financial officer, principal accounting officer or controller,
or persons performing similar functions, regardless of whether these
individuals are employed by the registrant or a third party, that relates
to one or more of the items set forth in paragraph (b) of this item's
instructions.
(e) Not applicable.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
As of the end of the period covered by the report, the registrant's Board of
Trustees has determined that Thomas R. Kadlec and Robert F. Keith are qualified
to serve as audit committee financial experts serving on its audit committee and
that each of them is "independent," as defined by Item 3 of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) Audit Fees (Registrant) -- The aggregate fees billed for each of the
last two fiscal years for professional services rendered by the principal
accountant for the audit of the registrant's annual financial statements or
services that are normally provided by the accountant in connection with
statutory and regulatory filings or engagements were $74,500 for the fiscal year
ended October 31, 2014 and $114,500 for fiscal year ended October 31, 2015.
(b) Audit-Related Fees (Registrant) -- The aggregate fees billed in each
of the last two fiscal years for assurance and related services by the principal
accountant that are reasonably related to the performance of the audit of the
registrant's financial statements and are not reported under paragraph (a) of
this Item were $0 for the fiscal year ended October 31, 2014, and $0 for the
fiscal year ended October 31, 2015.
Audit-Related Fees (Investment Adviser) -- The aggregate fees billed in
each of the last two fiscal years for assurance and related services by the
principal accountant that are reasonably related to the performance of the audit
of the registrant's financial statements and are not reported under paragraph
(a) of this Item were $0 for the fiscal year ended October 31, 2014, and $0 for
the fiscal year ended October 31, 2015.
(c) Tax Fees (Registrant) -- The aggregate fees billed in each of the last
two fiscal years for professional services rendered by the principal accountant
for tax compliance, tax advice, and tax planning to the registrant were $4,125
for the fiscal year ended October 31, 2014 and $12,675 for fiscal year ended
October 31, 2015.
Tax Fees (Investment Adviser and Distributor) -- The aggregate fees billed
in each of the last two fiscal years for professional services rendered by the
principal accountant for tax compliance, tax advice, and tax planning to the
registrant's adviser and distributor were $0 for the fiscal year ended October
31, 2014, and $0 for the fiscal year ended October 31, 2015.
(d) All Other Fees (Registrant) -- The aggregate fees billed in each of
the last two fiscal years for products and services provided by the principal
accountant to the registrant, other than the services reported in paragraphs (a)
through (c) of this Item were $0 for the fiscal year ended October 31, 2014, and
$0 for the fiscal year ended October 31, 2015.
All Other Fees (Investment Adviser and Distributor) -- The aggregate fees
billed in each of the last two fiscal years for products and services provided
by the principal accountant to the registrant's investment adviser and
distributor, other than the services reported in paragraphs (a) through (c) of
this Item were $0 for the fiscal year ended October 31, 2014, and $0 for the
fiscal year ended October 31, 2015.
(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c) (7) of Rule 2-01 of Regulation S-X.
Pursuant to its charter and its Audit and Non-Audit Services Pre-Approval
Policy, the Audit Committee (the "Committee") is responsible for the
pre-approval of all audit services and permitted non-audit services (including
the fees and terms thereof) to be performed for the registrant by its
independent auditors. The Chairman of the Committee is authorized to give such
pre-approvals on behalf of the Committee up to $25,000 and report any such
pre-approval to the full Committee.
The Committee is also responsible for the pre-approval of the independent
auditor's engagements for non-audit services with the registrant's adviser (not
including a sub-adviser whose role is primarily portfolio management and is
sub-contracted or overseen by another investment adviser) and any entity
controlling, controlled by or under common control with the investment adviser
that provides ongoing services to the registrant, if the engagement relates
directly to the operations and financial reporting of the registrant, subject to
the de minimis exceptions for non-audit services described in Rule 2-01 of
Regulation S-X. If the independent auditor has provided non-audit services to
the registrant's adviser (other than any sub-adviser whose role is primarily
portfolio management and is sub-contracted with or overseen by another
investment adviser) and any entity controlling, controlled by or under common
control with the investment adviser that provides ongoing services to the
registrant that were not pre-approved pursuant to its policies, the Committee
will consider whether the provision of such non-audit services is compatible
with the auditor's independence.
(e)(2) The percentage of services described in each of paragraphs (b)
through (d) for the registrant and the registrant's investment adviser and
distributor of this Item that were approved by the audit committee pursuant to
the pre-approval exceptions included in paragraph (c)(7)(i)(C) or
paragraph(C)(7)(ii) of Rule 2-01 of Regulation S-X are as follows:
Registrant: Adviser and Distributor:
----------- ------------------------
(b) 0% (b) 0%
(c) 0% (c) 0%
(d) 0% (d) 0%
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most recent
fiscal year that were attributed to work performed by persons other than the
principal accountant's full-time, permanent employees was less than fifty
percent.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's investment
adviser (not including any sub-adviser whose role is primarily portfolio
management and is subcontracted with or overseen by another investment adviser),
and any entity controlling, controlled by, or under common control with the
adviser that provides ongoing services to the registrant for fiscal year end
2014 were $4,125 for the registrant, $43,500 for the registrant's investment
adviser, $3,000 for the registrant's investment sub-adviser and $36,000 for the
registrant's distributor and for the registrant's fiscal year ended October 31,
2015 were $12,675 for the registrant, $12,500 for the registrant's investment
adviser, $3,000 for the registrant's investment sub-adviser and $36,500 for the
registrant's distributor.
(h) The registrant's audit committee of its Board of Trustees has
determined that the provision of non-audit services that were rendered to the
registrant's investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen by another
investment adviser), and any entity controlling, controlled by, or under common
control with the investment adviser that provides ongoing services to the
registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X is compatible with maintaining the principal accountant's
independence.
ITEMS 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
The registrant has a separately designated standing audit committee established
in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934.
The audit committee of the registrant is comprised of: Richard E. Erickson,
Thomas R. Kadlec, Robert F. Keith and Niel B. Nielson.
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.
Not applicable.
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 last fiscal quarter of
the period covered by this report that have materially affected, or are
reasonably likely to materially affect, the registrant's internal control
over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics, or any amendment thereto, that is the subject of
disclosure required by Item 2 is attached hereto.
(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 Exchange-Traded Fund III
-------------------------------------------------
By (Signature and Title)* /s/ Mark R. Bradley
----------------------------------------
Mark R. Bradley, President and
Chief Executive Officer
(principal executive officer)
Date: December 21, 2015
-------------------
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: December 21, 2015
-------------------
By (Signature and Title)* /s/ James M. Dykas
----------------------------------------
James M. Dykas, Treasurer,
Chief Financial Officer and
Chief Accounting Officer
(principal financial officer)
Date: December 21, 2015
-------------------
* Print the name and title of each signing officer under his or her signature.