N-CSR 1 d866528dncsr.htm FORM N-CSR Form N-CSR
Table of Contents

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: 811-21869

 

 

NEXPOINT CREDIT STRATEGIES FUND

 

 

(Exact name of registrant as specified in charter)

200 Crescent Court

Suite 700

Dallas, Texas 75201

 

 

(Address of principal executive offices)(Zip code)

NexPoint Advisors, L.P.

200 Crescent Court

Suite 700

Dallas, Texas 75201

 

 

(Name and Address of Agent for Service)

Registrant’s telephone number, including area code: (877) 665-1287

Date of fiscal year end: December 31

Date of reporting period: December 31, 2014


Table of Contents

Item 1. Reports to Stockholders.

A copy of the Report to Shareholders transmitted to shareholders pursuant to Rule 30e-1 under the Investment Company Act of 1940, as amended (the “1940 Act”), is attached herewith.


Table of Contents

LOGO

NexPoint Credit Strategies Fund

 

 

Annual Report

December 31, 2014

 

 


Table of Contents

NexPoint Credit Strategies Fund

TABLE OF CONTENTS

 

Portfolio Manager Commentary

     1   

Fund Profile

     5   

Financial Statements

     6   

Investment Portfolio

     7   

Statement of Assets and Liabilities

     12   

Statement of Operations

     13   

Statements of Changes in Net Assets

     14   

Statement of Cash Flows

     15   

Financial Highlights

     16   

Notes to Financial Statements

     17   

Report of Independent Registered Public Accounting Firm

     32   

Additional Information

     33   

Important Information About This Report

     42   

Economic and market conditions change frequently.

There is no assurance that the trends described in this report will continue or commence.

 

Privacy Policy

We recognize and respect your privacy expectations, whether you are a visitor to our web site, a potential shareholder, a current shareholder or even a former shareholder.

Collection of Information. We may collect nonpublic personal information about you from the following sources:

 

  Ÿ  

Account applications and other forms, which may include your name, address and social security number, written and electronic correspondence and telephone contacts;

  Ÿ  

Web site information, including any information captured through the use of “cookies”; and

  Ÿ  

Account history, including information about the transactions and balances in your accounts with us or our affiliates.

Disclosure of Information. We may share the information we collect with our affiliates. We may also disclose this information as otherwise permitted by law. We do not sell your personal information to third parties for their independent use.

Confidentiality and Security of Information. We restrict access to nonpublic personal information about you to our employees and agents who need to know such information to provide products or services to you. We maintain physical, electronic and procedural safeguards that comply with federal standards to guard your nonpublic personal information, although you should be aware that data protection cannot be guaranteed.


Table of Contents

PORTFOLIO MANAGER COMMENTARY (unaudited)

 

December 31, 2014   NexPoint Credit Strategies Fund

2014: Keeping Our Eye on the Prize

We are pleased to report strong 2014 results for the NexPoint Credit Strategies Fund’s (the “Fund”) shareholders. Beginning in the summer of 2012 we refocused the priorities in three key areas: Portfolio repositioning to increase distributable income and potential capital gains, reducing operation expenses, and taking structural improvement measures. These goals have not been pushed to the backburner, but have become a cornerstone in our management style in an attempt to provide shareholders the most bang for their buck. The past two and half years have demonstrated that staying true to our reengineered set of values can pay dividends, and the shareholders have been rewarded with above average performance because of it. The Fund had the best NAV performance of all closed-end funds in Morningstar’s Tactical Allocation Category and was one of only 66 credit oriented funds to increase its dividend on average from the preceding year. As of December 31, 2014, the Fund paid a monthly dividend of $.06 per share and had an undistributed net investment income balance of $17.8 million or $.28 per share annually.

2014 Performance

In 2014, the Fund returned 26.24% and the stock price was up 26.77%, including reinvested dividends. The Fund’s performance compared very favorably to the Fund’s benchmark, the Credit Suisse Hedge Fund Index (+ 4.12%) as well as to other credit focused closed-end funds. In 2014, 66 credit funds increased their dividend, 116 credit funds decreased their dividend 17.13% on average and 21 credit funds left their dividend unchanged (source: Morningstar, includes only credit oriented funds). The Fund increased its regular monthly dividend two times during 2014 for a total increase of 20%.

 

NexPoint Credit Strategies Fund   

One Year

    

Three Years

    

Five Years

    

Inception
To Date

 
NAV      26.24      32.92      21.59      5.32
Market Price      26.77      30.28      20.49      2.53

For the year, the top five performing investments in the portfolio were American Airlines common stock, Freedom REIT LLC, LLV Holdco LLC Litigation Trust Units, Argentine Sovereign Bonds, and Fortinet, Inc. common stock. The top five underperforming investments in the portfolio in 2014 were Media General, Inc. common stock, K12, Inc. common stock, MEG Energy Corp. common stock, Commvault Systems, Inc. common stock, and Chesapeake Energy Corp. common stock. In 2014, the Fund’s equity investments outperformed all other asset classes contributing 13.66% to the Fund’s NAV. Real Estate was the second best performing asset class contributing 5.12% to the Fund’s NAV.

Big Picture Highlights

We initiated the Argentine sovereign bond position during the second quarter of 2014 at depressed levels in advance of the July 2014 default deadline. A century ago Argentina was the fourth wealthiest country in the world. Through mismanagement and poor economic policies the country has a cost of capital in the teens despite having a well educated population and a wealth of natural resources. We believe the Argentine government is appropriately motivated to reach a commercial resolution in advance of the country’s presidential primary elections in 2015. The strategy of convergence seeks to identify discrepancies in the values of securities that have historically been much closer than current levels. This theme also serves as a hedge; as an example, certain commodity positions within this theme have historically exhibited low correlations with fixed income and equity securities.

During the reporting period, the Fund increased its exposure in a privately held REIT. In late September, the fund announced a plan to spin-off NexPoint Residential Trust Inc. (“NXRT”) and plans to list NXRT on the New York Stock Exchange once the spin-off is completed. On January 26, 2015, the board of the Fund announced that Fund shareholders of records on February 17, 2015 were being asked to approve the advisory agreement between NXRT and NexPoint Real Estate Advisors, L.P. at a special meeting of the shareholders to be held on March 6, 2015. Although the board of NXRT will set the dividend policy, we believe NXRT will seek to have approximately $0.30 per share of original NHF shares of annual income available for distribution. Additionally, we believe NHF can maintain its current $0.70 per share of annual distributions. In other words, we believe NHF can maintain the same dividend on a lower NAV base, effectively increasing the yield.

 

Annual Report       1


Table of Contents

PORTFOLIO MANAGER COMMENTARY (unaudited)

 

December 31, 2014   NexPoint Credit Strategies Fund

As of December 31, 2013, the Fund’s investments were allocated among the following asset classes:

 

LOGO

As of December 31, 2014, the Fund’s investments were allocated among the following asset classes:

 

LOGO

For the twelve-month period ended December 31, 2014, the Fund returned 26.24% leading the Morningstar’s Tactical Allocation category during the period. During 2014, the Fund steadily increased its allocation of the portfolio to real estate through a wholly-owned private REIT subsidiary that invests directly in real estate.

The Fund’s Strategy

The Fund’s investment adviser manages the Fund pursuant to a multi-strategy investment program that attempts to exceed the return of the Fund’s benchmark in a transparent, registered fund format, with monthly dividends. We will typically allocate the Fund’s investments in the following asset classes: public equities, private equity investments, collateralized loan obligation (CLOs) debt, high yield bonds, syndicated floating rate bank loans, real estate assets, CLO equity, non-traditional yield oriented investments and may hedge exposure where necessary.

 

1 

“Other” includes equity investments that were restructured from original debt investments

2 

The hedge category refers to positions, whether debt or equity, the Fund has invested in with the goal of providing a non-correlated return to certain asset classes or positions in an attempt to limit risk and reduce volatility.

 

2       Annual Report


Table of Contents

PORTFOLIO MANAGER COMMENTARY (unaudited)

 

December 31, 2014   NexPoint Credit Strategies Fund

Our View of the Year Ahead

We believe deflationary fears will be prevalent throughout the year ahead. As a result we expect to target hard asset investments with a clear supply/demand imbalance that are subjected to scarcity issues. Oil recently joined grains and metals on the list of commodities near their lows; however, we expect a first quarter bounce in oil from its lows. The dislocation of energy related investments that do not have meaningful fundamental correlation with oil prices has created an interesting opportunity set. Opportunistically, we expect we will look for investments that have been subjected to a broad energy sector sell off but have good underlying fundamentals, even in a depressed commodity environment. The oil related opportunities we are currently focused on are generally profitable in a medium-term price environment ($70-80/barrel). While we think a short-term bounce will likely occur, we do not believe we need oil prices to return to $90-100/barrel for our thesis to play out. Our investments in airlines continue to see robust fundamental performance and we believe they will see significant additional earnings tailwinds from lower oil prices — as industry players are not expected to have to give back price, so long as demand remains stable/growing — which is our expectation.

On the credit front, we are finding technical spillover from the oil/energy credit sell off into other industries creating some of the best buying opportunities in corporate credit in nearly two years. Domestic equity valuations are mid-range at best, but we believe the strong dollar will be a headwind for large caps. Typically, equity market improvement hinges on three things:

 

   

Rates remaining low and monetary policy makers moving slowly and gradually

 

   

S&P earnings will not be significantly impacted by dollar appreciation and slow global growth

 

   

Monetary policy keeping volatility low, facilitating risk taking and preventing a currency crisis.

We believe equities will muddle through in 2015. Predictions of a 10% increase are high in our opinion after aggregate returns of 63% in equities the past three years. In 2014, we positioned our equity portfolio under the thesis that domestic equity markets were fairly valued and that superior stock selection would produce outsized returns. This played out as less of the market’s performance was driven by multiple expansion and more by short term technical pullbacks and company fundamentals versus broad market appreciation.

This favored our security selection where we relied on our experienced team of credit and equity professionals to generate fundamental and technical investment opportunities within thematically strong sectors. The strength of the dollar is likely to create pressure for multi-national, large-cap US equities not only from the perspective of earnings in foreign operations (~45% of S&P revenues are typically derived from outside the US), but also pressure on US export demand as foreigners lose buying power for importing US goods.

We are generally long idiosyncratic risk and short systemic risk in the portfolio, meaning we don’t hold a lot of the highly correlated large cap equities. Instead we seek to hold meaningful position sizes in our high conviction names including energy names like NRG and APC along with contrarian value names; Argentina, American Airlines, and Staples. The success of these positions are typically not as dependent on general economic activity.

Yields are generally trending lower again while the yield curve flattens. We expect rate tightening by the Federal Reserve to be pushed off further into 2015 and beyond. We believe Fed policies represent potential for further market volatility over the coming year. The volatility we believe will be prevalent in 2015 makes active management even more important, in our opinion, both from a stock selection and an exposure management perspective. We are short duration in general, which means we are generally long credit risk and short interest rate risk. With our credit underwriting platform and uncertainty in interest rates, we feel comfortable in this allocation. While rates may creep down we don’t believe the investor is adequately compensated through market timing rate risk by moving up and down the duration curve. We believe well underwritten credit risk in 2015 represents a superior risk/return profile in the hands of the right active manager.

 

Annual Report       3


Table of Contents

PORTFOLIO MANAGER COMMENTARY (unaudited)

 

December 31, 2014   NexPoint Credit Strategies Fund

Emerging markets appear to be bouncing around support but fundamental news has remained weak, and a bounce or break in first quarter will probably define their year. Our 2014 thesis of China- shifting monetary support from banks to attracting risk capital into local equity markets-played out well in part evidenced by the merger of the Shanghai and Hong Kong stock exchanges.

This and other types of artificial support of capital markets created regional momentum in equity valuations that may or may not be supported by underlying economic or corporate fundamentals. We are considering similar monetary policy backdrops when evaluating the attractiveness of China and other emerging markets.

From a fundamental perspective geopolitical uncertainties are generally keeping us away from making regional bets with the exception of China and India. We prefer to carefully underwrite issuer specific risks such as Argentina where we believe we have a differentiated view from the market on a contractual security (versus pure speculation) that has event-driven catalysts that will result in a revaluation of the asset.

We believe that the equity tape is split and there has been 6 S&P Hindenburg Omens and 6 NASDAQ Hindenburgs between Thanksgiving and December 31, 2014. The Hindenburg Omen is a technical measure that the team has found interesting recently and signifies the existence of an unusually large number of simultaneous new highs/lows in the market. When this occurs there is typically no consensus on market direction and a higher dispersion of returns between securities. If this persists it will likely result in a lower correlation between stocks and represents an environment in which good active management should outperform.

We expect to position the portfolio throughout the year to reflect our macro and fundamental views of the market.

Shareholder Loyalty Program

In July 2012, we developed and implemented a unique and creative Shareholder Loyalty Program (the “Program”) that we believe rewards long-term shareholders while aligning the interests of the portfolio manager and other employees of the manager with those of the Fund’s shareholders. The primary purpose of the Program is to promote shareholder loyalty. Subject to certain limitations, the Program offers shareholders a 2% gross-up on all new contributions made through accounts held by the Program’s administrator that are held for at least 12-months after initial purchase date. The Program was offered to employees of NexPoint and affiliates beginning in July 2012 and has increased direct employee ownership in the Fund. All costs of the program, including the cost of the gross-up on purchases and dividend reinvestments, are paid by the manager, not by the Fund.

James Dondero

President and Portfolio Manager

 

4       Annual Report


Table of Contents

FUND PROFILE (unaudited)

 

  NexPoint Credit Strategies Fund

Objective

The NexPoint Credit Strategies Fund (the “Fund”) seeks to provide both current income and capital appreciation.

 

Total Net Assets of Common Shares as of December 31, 2014

$860.9 million

 

Portfolio Data as of December 31, 2014

The information below provides a snapshot of the Fund at the end of the reporting period. The Fund is actively managed and the composition of its portfolio will change over time.

 

Quality Breakdown as of 12/31/2014 (%)(1)  

BBB

       2.0   

BB

       17.8   

B

       18.4   

CCC

       12.3   

C

       0.2   

Not Rated

       49.3   

 

Top 5 Sectors as of 12/31/2014 (%)(2)  

Real Estate

       35.7   

Financial

       18.4   

Consumer Discretionary

       15.8   

Asset-Backed Securities

       15.2   

Media & Telecommunications

       13.2   
 

 

Top 10 Holdings as of 12/31/2014 (%)(2)  

Freedom REIT (Common Stocks & Exchange-Traded Funds)

       32.4   

American Airlines Group, Inc. (Common Stocks & Exchange-Traded Funds)

       12.3   

Media General, Inc. (Common Stocks & Exchange-Traded Funds)

       9.6   

Anadarko Petroleum Corp. (Common Stocks & Exchange-Traded Funds)

       4.8   

Grayson CLO, Ltd. (Preferred Stocks)

       4.1   

Microsoft Corp. (Common Stocks & Exchange-Traded Funds)

       3.7   

NRG Energy, Inc. (Common Stocks & Exchange-Traded Funds)

       3.7   

Comcorp Broadcasting, Inc. (U.S. Senior Loans)

       3.4   

Argentine Republic Government International Bond (Sovereign Bonds)

       3.4   

Metro-Goldwyn-Mayer, Inc., Class A  (Common Stocks & Exchange-Traded Funds)

       2.7   

 

(1) 

Quality is calculated as a percentage of total senior loans, asset-backed securities and corporate bonds & notes. The quality ratings reflected were issued by Standard & Poor’s, a nationally recognized statistical rating organization. Ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest). Quality ratings reflect the credit quality of the underlying bonds in the Fund’s portfolio and not that of the Fund itself. Credit quality ratings assigned by a rating agency are subjective opinions, not statements of fact, and are subject to change, including daily. The ratings assigned by credit rating agencies are but one of the considerations that the Fund’s investment adviser incorporates into its credit analysis process, along with such other issuer-specific factors as cash flows, capital structure and leverage ratios, ability to de-leverage through free cash flow, quality of management, market positioning and access to capital, as well as such security-specific factors as the terms of the security (e.g., interest rate, and time to maturity) and the amount of any collateral. Quality Ratings are subject to change.

 

(2) 

Sectors and holdings are calculated as a percentage of total net assets.

 

Annual Report       5


Table of Contents

FINANCIAL STATEMENTS

 

December 31, 2014   NexPoint Credit Strategies Fund

A guide to understanding the Fund’s financial statements

 

Investment Portfolio      The Investment Portfolio details all of the Fund’s holdings and their value as of the last day of the reporting period. Portfolio holdings are organized by type of asset and industry to demonstrate areas of concentration and diversification.
Statement of Assets and Liabilities      This statement details the Fund’s assets, liabilities, net assets and common share price as of the last day of the reporting period. Net assets are calculated by subtracting all the Fund’s liabilities (including any unpaid expenses) from the total of the Fund’s investment and non-investment assets. The net asset value per common share is calculated by dividing net assets by the number of common shares outstanding as of the last day of the reporting period.
Statement of Operations      This statement reports income earned by the Fund and the expenses accrued by the Fund during the reporting period. The Statement of Operations also shows any net gain or loss the Fund realized on the sales of its holdings during the period as well as any unrealized gains or losses recognized over the period. The total of these results represents the Fund’s net increase or decrease in net assets from operations applicable to common shareholders.
Statements of Changes in Net Assets      These statements detail how the Fund’s net assets were affected by its operating results, distributions to common shareholders and shareholder transactions from common shares (e.g., subscriptions, redemptions and distribution reinvestments) during the reporting period. The Statements of Changes in Net Assets also detail changes in the number of common shares outstanding.
Statement of Cash Flows      This statement reports net cash and foreign currency provided or used by operating, investing and financing activities and the net effect of those flows on cash and foreign currency during the period.
Financial Highlights      The Financial Highlights demonstrate how the Fund’s net asset value per common share was affected by the Fund’s operating results. The Financial Highlights also disclose the Fund’s performance and certain key ratios (e.g., net expenses and net investment income as a percentage of average net assets).
Notes to Financial Statements      These notes disclose the organizational background of the Fund, its significant accounting policies (including those surrounding security valuation, income recognition and distributions to shareholders), federal tax information, fees and compensation paid to affiliates and significant risks and contingencies.

 

6       Annual Report


Table of Contents

INVESTMENT PORTFOLIO

 

As of December 31, 2014   NexPoint Credit Strategies Fund

    Principal Amount ($)    

 

    Value ($)    

 

 

U.S. Senior Loans (a) - 11.2%

  

  BROADCASTING - 3.4%   
  29,151,613     

Comcorp Broadcasting, Inc.
Term Loan B
5.76%, 04/01/2015

    29,151,613   
   

 

 

 
  GAMING & LEISURE - 0.6%   
  3,883,480     

Ginn-LA CS Borrower LLC
First Lien Tranche A Credit-Linked Deposit (b)

    77,670   
  8,322,966     

First Lien Tranche B Term Loan (b)

    166,459   
  8,286,626     

LLV Holdco LLC
Exit Revolving Loan
5.06%, 02/28/2017 (c)(d)

    4,596,592   
   

 

 

 
      4,840,721   
   

 

 

 
  HEALTHCARE - 0.2%   
  2,220,000     

Surgery Center Holdings, Inc. Second Lien Term Loan
11/03/2021 (e)

    2,150,625   
   

 

 

 
  HOUSING - 0.0%   
  2,444,876     

LBREP/L-SunCal Master I LLC
First Lien Term Loan (b)(d)

    72,857   
   

 

 

 
  MEDIA & TELECOMMUNICATIONS - 0.0%   
  2,586,144     

Endurance Business Media, Inc.
Term Loan (b)(d)

      
   

 

 

 
  SERVICE - 1.3%   
  14,828,952     

Weight Watchers International, Inc.
Tranche B-2 Initial Term Loan
4.00%, 04/02/2020

    11,470,195   
   

 

 

 
  TELECOMMUNICATIONS - 0.8%   
  6,637,538     

TerreStar Corp.
Term Loan
8.50%, 10/14/2017 (d)

    6,637,538   
   

 

 

 
  UTILITY - 4.9%   
  8,184,064     

Entegra TC LLC
Term Loan
9.25%, 10/02/2020

    7,883,995   
  17,000,000     

Texas Competitive Electric Holdings Co. LLC
Non-Extended Term Loan
4.65%, 10/10/2015

    10,947,320   
  35,329,417     

Extended Term Loan
4.65%, 10/10/2017

    22,964,121   
   

 

 

 
      41,795,436   
   

 

 

 
 

Total U.S. Senior Loans
(Cost $121,034,064)

    96,118,985   
   

 

 

 

    Principal Amount    

     

 
 

Foreign Denominated or Domiciled Senior
Loans (a) - 0.5%

  
  

  AUSTRALIA - 0.0%   
  USD   
  300,000     

Aufinco Pty, Ltd.
Second Lien Term Loan
7.25%, 11/30/2020

    295,500   
   

 

 

 

    Principal Amount    

 

    Value ($)    

 
  LUXEMBOURG – 0.3%   
  USD   
  2,727,273     

Travelport Finance S.a.r.l.
Initial Term Loan
6.00%, 09/02/2021

    2,727,273   
   

 

 

 
  MARSHALL ISLANDS – 0.2%   
  USD   
  1,516,162     

Drillships Financing Holding, Inc. Tranche B-1 Term Loan 03/31/2021 (e)

    1,196,827   
   

 

 

 
  UNITED KINGDOM - 0.0%   
  GBP   
  773,100     

Henson No. 4, Ltd.
Term Loan Facility B (b)(d)

    43,637   
  949,116     

Term Loan Facility C (b)(d)

    44,075   
   

 

 

 
      87,712   
   

 

 

 
 

Total Foreign Denominated or Domiciled Senior Loans
(Cost $5,950,723)

    4,307,312   
   

 

 

 

    Principal Amount ($)    

     

 

Asset-Backed Securities (f)(g) - 15.2%

  

  1,174,797     

ACA CLO, Ltd.
Series 2007-1A, Class E
4.98%, 06/15/2022

    1,119,522   
  6,000,000     

Acis CLO, Ltd.
Series 2014-3A, Class D
3.35%, 02/01/2026

    5,271,600   
  10,000,000     

Series 2014-3A, Class E 4.98%, 02/01/2026

    8,477,500   
  2,000,000     

Series 2013-2A, Class E
5.16%, 10/14/2022

    1,845,000   
  4,500,000     

Series 2013-1A, Class E
5.83%, 04/18/2024

    4,187,822   
  5,000,000     

Series 2014-3A, Class F
5.83%, 02/01/2026

    4,175,000   
  9,142,000     

Series 2013-1A, Class F
6.73%, 04/18/2024

    8,126,324   
  3,000,000     

AIMCO CLO
Series 2014-AA, Class E
4.82%, 07/20/2026

    2,595,000   
  1,000,000     

Apidos CLO
Series 2013-12A, Class F
5.13%, 04/15/2025

    850,900   
 

Catamaran CLO, Ltd.

 
  3,000,000     

Series 2013-1A, Class E
5.23%, 01/27/2025

    2,692,500   
  250,000     

Series 2012-1A, Class E
5.50%, 12/20/2023

    237,099   
  2,000,000     

CFIP CLO, Ltd.
Series 2014-1A, Class E
4.98%, 04/13/2025

    1,732,520   
  2,000,000     

CIFC Funding, Ltd.
Series 2014-4A, Class F
5.89%, 10/17/2026

    1,674,200   
  1,000,000     

Dryden XXV Senior Loan Fund
Series 2012-25A, Class E
5.73%, 01/15/2025

    940,000   
 

 

See accompanying Notes to Financial Statements.       7


Table of Contents

INVESTMENT PORTFOLIO (continued)

 

As of December 31, 2014   NexPoint Credit Strategies Fund

    Principal Amount ($)    

 

    Value ($)    

 

 

Asset-Backed Securities (continued)

  

  15,510,000     

Eastland CLO, Ltd.
Series 2007-1A, Class C
1.73%, 05/01/2022

    13,625,535   
  3,375,116     

Series 2007-1A, Class D
3.76%, 05/01/2022

    2,991,196   
  1,000,000     

Flagship CLO VIII, Ltd.
Series 2014-8A, Class F
6.05%, 01/16/2026

    835,000   
  2,000,000     

Flagship CLO, Ltd.
Series 2014-8A, Class D
3.90%, 01/16/2026

    1,860,000   
  5,000,000     

Series 2014-8A, Class E
5.40%, 01/16/2026

    4,400,000   
 

Grayson CLO, Ltd.

 
  2,000,000     

Series 2006-1A, Class C
1.78%, 11/01/2021

    1,767,800   
  2,915,407     

Series 2006-1A, Class D
3.83%, 11/01/2021

    2,513,810   
  850,000     

Greywolf CLO, Ltd.
Series 2013-1A, Class E
5.28%, 04/15/2025

    711,535   
  1,500,000     

Halcyon Loan Investors CLO, Inc.
Series 2006-1A, Class D
3.73%, 11/20/2020

    1,451,250   
  3,000,000     

Harbourview CLO, Ltd.
Series 7A, Class E
5.36%, 11/18/2026

    2,647,500   
  2,127,119     

Hewett’s Island CDO, Ltd.
Series 2007-1RA, Class E
6.98%, 11/12/2019

    2,087,767   
  9,842,524     

Highland Park CDO, Ltd.
Series 2006-1A, Class A1
0.56%, 11/25/2051

    9,288,882   
  362,072     

Series 2006-1X, Class A1
0.56%, 11/25/2051

    341,706   
  11,375,000     

Series 2006-1A, Class A2
0.63%, 11/25/2051

    6,483,750   
  1,000,000     

Marquette U.S./European CLO LLC
Series 2006-1A, Class D1
1.98%, 07/15/2020

    980,435   
  3,500,000     

Neuberger Berman CLO, Ltd.
Series 2012-13A, Class E
5.33%, 01/23/2024

    3,229,240   
  3,500,000     

Newmark Capital Funding CLO, Ltd.
Series 2013-1A, Class E
4.88%, 06/02/2025

    3,045,000   
  1,000,000     

Palmer Square CLO, Ltd.
Series 2013-2A, Class D
5.58%, 10/17/2025

    905,300   
  1,000,000     

PPM Grayhawk CLO, Ltd.
Series 2007-1A, Class C
1.63%, 04/18/2021

    917,500   
  2,000,000     

Primus CLO II, Ltd.
Series 2007-2A, Class D

2.63%, 07/15/2021

    1,813,400   
  944,878     

Series 2007-2A, Class E
4.98%, 07/15/2021

    860,783   
  4,620,339     

Red River CLO, Ltd.
Series 1A, Class E
3.98%, 07/27/2018

    4,366,221   

    Principal Amount ($)    

 

    Value ($)    

 
  6,000,000     

Rockwall CDO II, Ltd.
Series 2007-1A, Class A3L
1.23%, 08/01/2024

    5,220,000   
  2,752,426     

Series 2007-1A, Class B2L
4.48%, 08/01/2024

    2,422,135   
  2,795,578     

Stratford CLO, Ltd.
Series 2007-1A, Class E
4.23%, 11/01/2021

    2,479,328   
  2,000,000     

THL Credit Wind River CLO, Ltd.
Series 2014-2A, Class D

4.09%, 07/15/2026

    1,892,000   
  6,000,000     

Series 2014-2A, Class E
5.44%, 07/15/2026

    5,358,000   
  1,500,000     

Valhalla CLO, Ltd.
Series 2004-1A, Class EIN
0.00%, 08/01/2016

    440,000   
  2,100,000     

Vibrant CLO II, Ltd.
Series 2013-2A, Class E
5.73%, 07/24/2024

    1,711,500   
   

 

 

 
 

Total Asset-Backed Securities (Cost $125,410,028)

    130,571,560   
   

 

 

 

 

Corporate Bonds & Notes - 6.3%

  

  ENERGY - 0.4%   
  4,062,000     

Arch Coal, Inc.
7.00%, 06/15/2019 (h)

    1,238,910   
  5,000,000     

Venoco, Inc.
8.88%, 02/15/2019 (h)

    2,775,000   
   

 

 

 
      4,013,910   
   

 

 

 
  GAMING & LEISURE - 0.1%   
  4,923,000     

Caesars Entertainment Operating Co., Inc.
10.00%, 12/15/2018

    787,680   
   

 

 

 
  INFORMATION TECHNOLOGY - 2.4%   
  23,971,250     

Avaya, Inc.
10.50%, 03/01/2021 (f)(h)

    20,615,275   
   

 

 

 
  TRANSPORTATION - 0.1%   
  3,750,000     

DPH Holdings Corp. (b)

    138,750   
  3,933,000     

DPH Holdings Corp. (b)

    145,521   
  8,334,000     

DPH Holdings Corp. (b)

    308,358   
   

 

 

 
      592,629   
   

 

 

 
  UTILITY - 3.3%   
  9,645,470     

Entegra TC LLC
9.23%, 10/03/2017 (f)(g)

    9,693,697   
  14,839,000     

Ocean Rig UDW, Inc.
7.25%, 04/01/2019 (f)(h)

    10,535,690   
  10,190,069     

Texas Competitive Electric Holdings Co. LLC (b)(f)(h)

    3,562,500   
  24,000,000     

Texas Competitive Electric Holdings Co. LLC (b)(h)

    4,380,000   
   

 

 

 
      28,171,887   
   

 

 

 
 

Total Corporate Bonds & Notes
(Cost $68,844,210)

    54,181,381   
   

 

 

 
 

 

8       See accompanying Notes to Financial Statements.


Table of Contents

INVESTMENT PORTFOLIO (continued)

 

As of December 31, 2014   NexPoint Credit Strategies Fund

    Principal Amount    

 

    Value ($)    

 

 

Foreign Corporate Bonds & Notes - 0.6%

  

  CANADA - 0.5%   
  USD       
  5,069,000     

Tervita Corp.
8.00%, 11/15/2018 (f)(h)

    4,359,340   
   

 

 

 
  NETHERLANDS - 0.1%   
  USD       
  64,515,064     

Celtic Pharma Phinco BV, PIK (b)

    645,151   
  28,665,284     

Celtic Pharma Phinco BV, PIK (b)(d)

      
   

 

 

 
      645,151   
   

 

 

 
 

Total Foreign Corporate Bonds & Notes
(Cost $67,323,527)

    5,004,491   
   

 

 

 

    Principal Amount ($)    

     

 

Sovereign Bonds (b)(h) - 8.7%

  

  SOVEREIGN BONDS - 8.7%   
 

Argentine Republic Government International Bond

 
  10,000,000     

2.50%, 12/31/2038 (i)

    5,150,000   
  27,522,000     

7.82%, 12/31/2033

    28,973,611   
  20,641,537     

7.82%, 12/31/2033

    21,730,248   
  14,020,400     

8.28%, 12/31/2033

    12,583,309   
  7,010,200     

8.28%, 12/31/2033

    6,133,925   
   

 

 

 
      74,571,093   
   

 

 

 
 

Total Sovereign Bonds
(Cost $77,458,847)

    74,571,093   
   

 

 

 

    Shares    

     

 

Common Stocks & Exchange-Traded Funds - 91.3%

  

  BROADCASTING - 0.3%   
  2,317,006     

Communications Corp. of America (d)(p)

    2,826,747   
   

 

 

 
  CONSUMER DISCRETIONARY - 16.1%   
  1,972,975     

American Airlines Group, Inc. (h)(j)

    105,810,649   
  24,950     

Apollo Group, Inc., Class A (j)(k)

    851,045   
  2,050     

Coca-Cola Enterprises, Inc. (h)

    90,651   
  1,477,468     

K12, Inc. (h)(j)(k)

    17,537,545   
  804,075     

Staples, Inc. (h)(j)

    14,569,839   
   

 

 

 
      138,859,729   
   

 

 

 
  CONSUMER STAPLES - 0.0%   
  2,650     

Dr. Pepper Snapple Group, Inc. (j)

    189,952   
   

 

 

 
  ENERGY - 7.6%   
  500,000     

Anadarko Petroleum Corp. (h)(j)

    41,250,000   
  846,780     

Atlantic Power Corp. (h)

    2,294,774   
  3,360     

California Resources Corp. (k)

    18,513   
  340,000     

MEG Energy Corp. (k)

    5,738,830   
  8,400     

Occidental Petroleum Corp. (h)

    677,124   
  1,685,428     

Ocean Rig UDW, Inc. (h)(j)

    15,640,772   
   

 

 

 
      65,620,013   
   

 

 

 
  FINANCIAL - 2.1%   
  1,000,000     

Adelphia Recovery Trust (k)

    2,400   
  46,601     

American Banknote Corp. (d)

    294,984   

    Shares    

 

    Value ($)    

 
  83,904     

MPM Holdings, Inc

    2,359,800   
  4,762,223     

Specialty Finance, Inc. (d)(l)(q)

    4,630,310   
  1,175,233     

SWS Group, Inc. (h)(j)(k)

    8,120,860   
  48,025     

Torchmark Corp. (j)

    2,601,514   
   

 

 

 
      18,009,868   
   

 

 

 
  GAMING & LEISURE - 0.0%   
  14     

LLV Holdco LLC - Litigation Trust Units (d)(l)

      
  26,712     

LLV Holdco LLC - Series A, Membership Interest (d)(l)

      
  144     

LLV Holdco LLC - Series B, Membership Interest (d)(l)

      
   

 

 

 
        
   

 

 

 
  HEALTHCARE - 1.0%   
  24,000,000     

Genesys Ventures IA, LP (d)

    3,429,600   
  116,555     

ProShares UltraShort Nasdaq Biotechnology ETF (h)(j)

    5,361,530   
   

 

 

 
      8,791,130   
   

 

 

 
  HOUSING - 0.2%   
  368,150     

CCD Equity Partners LLC (d)

    1,239,193   
   

 

 

 
  INFORMATION TECHNOLOGY - 6.2%   
  833     

CDK Global, Inc.

    33,953   
  28,457     

CommVault Systems, Inc. (h)(k)

    1,470,942   
  261,635     

Corning, Inc. (h)(j)

    5,999,291   
  234,000     

Fortinet, Inc. (h)(j)(k)

    7,174,440   
  1     

Magnachip Semiconductor Corp. (k)

    13   
  681,150     

Microsoft Corp. (h)(j)

    31,639,417   
  27,450     

NetApp, Inc. (j)

    1,137,803   
  124,350     

Teradata Corp. (h)(j)(k)

    5,431,608   
   

 

 

 
      52,887,467   
   

 

 

 
  MEDIA & TELECOMMUNICATIONS - 13.1%   
  6,480     

Endurance Business Media, Inc., Class A (d)(l)

      
  18,000     

Gray Television, Inc., Class A (h)(k)

    164,700   
  39,684     

Loral Space & Communications, Inc. (h)(k)

    3,123,528   
  4,938,971     

Media General, Inc. (k)

    82,628,985   
  308,875     

Metro-Goldwyn-Mayer, Inc., Class A (m)

    23,011,187   
  145,253     

MPM Holdings, Inc. (k)

    4,085,241   
  645     

Time, Inc.

    15,873   
   

 

 

 
      113,029,514   
   

 

 

 
  METALS & MINERALS - 2.6%   
  23,400     

Direxion Daily Gold Miners Bull 3x Shares, ETF (j)(k)

    261,144   
  27,200     

ProShares Ultra Gold, ETF (h)(k)

    1,044,752   
  554,553     

ProShares Ultra Silver, ETF (h)(k)

    21,100,742   
   

 

 

 
      22,406,638   
   

 

 

 
  REAL ESTATE - 0.0%   
  250,912     

Allenby (d)

      
  2,393,814     

Claymore (d)

    3   
   

 

 

 
      3   
   

 

 

 
 

 

See accompanying Notes to Financial Statements.       9


Table of Contents

INVESTMENT PORTFOLIO (continued)

 

As of December 31, 2014   NexPoint Credit Strategies Fund

    Shares    

 

    Value ($)    

 

 

Common Stocks & Exchange-Traded Funds (continued)

  

  REAL ESTATE INVESTMENT TRUST - 35.7%   
  15,006,336     

Freedom REIT (d)(l)

    278,967,787   
  1,457,100     

NexPoint Real Estate Capital, REIT (d)(l)

    15,051,843   
  200,000     

NexPoint Residential Trust, Inc., REIT (d)(l)

    2,000   
  1,150,027     

Spirit Realty Capital, Inc., REIT (h)(j)

    13,673,821   
   

 

 

 
      307,695,451   
   

 

 

 
  TELECOMMUNICATIONS - 1.4%   
  43     

TerreStar Corp. (d)

    12,325,733   
   

 

 

 
  UTILITY - 4.6%   
  26,220     

Entegra TC LLC, Class A

    7,472,700   
  1,272,973     

Entegra TC LLC, Class B

    50,919   
  1,173,263     

NRG Energy, Inc. (h)(j)

    31,619,438   
   

 

 

 
      39,143,057   
   

 

 

 
  WIRELESS COMMUNICATIONS - 0.4%   
  2,260,529     

Pendrell Corp. (h)(k)

    3,119,530   
   

 

 

 
 

Total Common Stocks &
Exchange-Traded Funds
(Cost $822,438,210)

    786,144,025   
   

 

 

 

 

Preferred Stocks (f) - 16.2%

  

  FINANCIAL - 16.2%   
  14,500     

Aberdeen Loan Funding, Ltd.

    6,996,250   
  1,200     

Brentwood CLO, Ltd.

    695,100   
  13,800     

Brentwood CLO, Ltd.

    7,993,650   
  34,500     

Eastland CLO, Ltd.

    23,008,050   
  5,000     

Eastland Investors Corp.

    3,334,500   
  62,600     

Grayson CLO, Ltd., Series II

    35,682,000   
  1,500     

Grayson Investors Corp.

    855,000   
  3,750     

Greenbriar CLO, Ltd.

    1,996,875   
  39,000     

Greenbriar CLO, Ltd.

    20,767,500   
  2,500     

Liberty CLO, Ltd.

    996,500   
  8,500     

Red River CLO, Ltd., Series PS-2

    3,179,750   
  10,500     

Rockwall CDO, Ltd.

    7,427,175   
  6,000     

Southfork CLO, Ltd.

    2,970,000   
  41,500     

Stratford CLO, Ltd.

    22,617,500   
  3,500     

Westchester CLO, Ltd.

    1,470,000   
   

 

 

 
      139,989,850   
   

 

 

 
 

Total Preferred Stocks
(Cost $151,849,900)

    139,989,850   
   

 

 

 

    Units    

 

 

Warrants (d)(k) - 0.0%

  

  GAMING & LEISURE - 0.0%   
  602     

LLV Holdco LLC - Series C, Membership Interest, expires 07/15/15

      
  828     

LLV Holdco LLC - Series D, Membership Interest, expires 07/15/15

      
  925     

LLV Holdco LLC - Series E, Membership Interest, expires 07/15/15

      
  1,041     

LLV Holdco LLC - Series F, Membership Interest, expires 07/15/15

      

    Units    

 

    Value ($)    

 
  1,179     

LLV Holdco LLC - Series G, Membership Interest, expires 07/15/15

      
   

 

 

 
        
   

 

 

 
 

Total Warrants
(Cost $—)

      
   

 

 

 

    Contracts    

 

 

Purchased Call Options - 2.5%

  

  2,000     

Anadarko Petroleum Corp., Strike price $70.00, expires 05/15/2015

    3,085,000   
  9,000     

Anadarko Petroleum Corp., Strike price $72.50, expires 01/15/2016

    15,435,000   
  1,050     

Anadarko Petroleum Corp., Strike price $90.00, expires 01/17/2015

    63,000   
  19,020     

NRG Energy, Inc., Strike price $30.00, expires 06/19/2015

    2,805,450   
  4,000     

NRG Energy, Inc., Strike price $31.00, expires 03/20/2015

    220,000   
   

 

 

 
 

Total Purchased Call Options
(Cost $18,393,748)

    21,608,450   
   

 

 

 

 

Total Investments - 152.5%

    1,312,497,147   
   

 

 

 

 

(Cost $1,458,703,257) (n)

 

 

Securities Sold Short - (3.8)%

 

 

Common Stocks & Exchange-Traded Funds - (3.8)%

  

  CONSUMER STAPLES - (0.3)%  
  19,350     

Keurig Green Mountain, Inc.

    (2,561,843
   

 

 

 
  CONSUMER DISCRETIONARY - (0.4)%  
  33,900     

Deckers Outdoor Corp. (o)

    (3,086,256
   

 

 

 
  ENERGY - (0.8)%  
  98,400     

Cheniere Energy, Inc. (o)

    (6,927,360
  8,452     

Seventy Seven Energy, Inc. (o)

    (45,724
   

 

 

 
      (6,973,084
   

 

 

 
  INFORMATION TECHNOLOGY - (0.9)%  
  70,150     

Zillow, Inc., Class A (o)

    (7,428,184
   

 

 

 
  HEALTHCARE - (1.4)%  
  16,000     

Alexion Pharmaceuticals, Inc. (o)

    (2,960,480
  266,800     

Myriad Genetics, Inc. (o)

    (9,087,208
   

 

 

 
      (12,047,688
   

 

 

 
 

Total Securities Sold Short
(Proceeds $33,641,632)

    (32,097,055
   

 

 

 

 

Other Assets & Liabilities, Net - (48.7)%

    (419,522,695
   

 

 

 

 

Net Assets - 100.0%

    860,877,397   
   

 

 

 
 

 

10       See accompanying Notes to Financial Statements.


Table of Contents

INVESTMENT PORTFOLIO (continued)

 

As of December 31, 2014   NexPoint Credit Strategies Fund

 

 

(a) Senior loans (also called bank loans, leveraged loans, or floating rate loans) in which the Fund invests generally pay interest at rates which are periodically determined by reference to a base lending rate plus a spread (unless otherwise identified, all senior loans carry a variable rate of interest). These base lending rates are generally (i) the Prime Rate offered by one or more major United States banks, (ii) the lending rate offered by one or more European banks such as the London Interbank Offered Rate (“LIBOR”) or (iii) the Certificate of Deposit rate. Rate shown represents the weighted average rate at December 31, 2014. Senior loans, while exempt from registration under the Securities Act of 1933 (the “1933 Act”), contain certain restrictions on resale and cannot be sold publicly. Senior secured floating rate loans often require prepayments from excess cash flow or permit the borrower to repay at its election. The degree to which borrowers repay, whether as a contractual requirement or at their election, cannot be predicted with accuracy. As a result, the actual remaining maturity may be substantially less than the stated maturity shown.
(b) The issuer is, or is in danger of being, in default of its payment obligation. Income is not being accrued.
(c) Fixed rate senior loan.
(d) Represents fair value as determined by the Fund’s Board of Trustees (the “Board”), or its designee in good faith, pursuant to the policies and procedures approved by the Board. Securities with a total aggregate value of $330,162,899, or 38.4% of net assets, were fair valued under the Fund’s valuation procedures as of December 31, 2014. Of this amount, $278,967,787, or 32.4% of net assets, is from the Fund’s investment in Freedom REIT, a portion of which is expected to spinoff in 2015. See Note 13.
(e) All or a portion of this position has not settled. Full contract rates do not take effect until settlement date.
(f) Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only be resold in transaction exempt from registration to qualified institutional buyers. At December 31, 2014, these securities amounted to $319,327,912 or 37.1% of net assets.
(g) Variable or floating rate security. The interest rate shown reflects the rate in effect December 31, 2014.
(h) All or part of the security is pledged as collateral for the Committed Facility Agreement with BNP Paribas Prime Brokerage, Inc. The market value of the securities pledged as collateral was $251,766,214.
(i) Step coupon bond. The interest rate shown reflects the rate in effect December 31, 2014 and will reset at a future date.
(j) All or part of this security is pledged as collateral for short sales. The market value of the securities pledged as collateral was $202,692,262 as of December 31, 2014.
(k) Non-income producing security.
(l) Affiliated issuer. Assets with a total aggregate market value of $298,651,940, or 34.7% of net assets, were affiliated with the Fund as of December 31, 2014. Of this amount, $278,967,787, or 32.4% of net assets, is from the Fund’s investment in Freedom REIT, a portion of which is expected to spinoff in 2015. See Note 13.
(m) Restricted Securities. These securities are not registered and may not be sold to the public. There are legal and/or contractual restrictions on resale. The Fund does not have the right to demand that such securities be registered. The values of these securities are determined by valuations provided by pricing services, brokers, dealers, market makers, or in good faith under the procedures established by the Fund’s Board of Trustees.
(n) Cost for U.S. federal income tax purposes is $1,441,604,725.
(o) No dividend payable on security sold short.
(p) Shares are held in an escrow account.
(q) This investment is made up of $113,000 in cash and the fair value of six life settlement contracts.

 

Currency Abbreviations:

EUR   Euro Currency
GBP   British Pound

Glossary:

CDO   Collateralized Debt Obligation
CLO   Collateralized Loan Obligation
ETF   Exchange-Traded Fund
PIK   Payment-in-Kind
REIT   Real Estate Investment Trust

Written options contracts outstanding as of December 31, 2014 were as follows:

 

Description   Exercise
Price
    Expiration
Date
    Number
of
Cont
racts
    Premium     Value  

WRITTEN PUT OPTIONS:

  

     

Written Options:

         

Anadarko Petro
leum Corp.

  $ 90.00        January 2015        1,050      $ 525,325      $ (890,400

NRG Energy, Inc.

    31.00        March 2015        4,000        770,695        (1,840,000
       

 

 

   

 

 

 

Total Written Options Contracts

  

  $ 1,296,020      $ (2,730,400
       

 

 

   

 

 

 

 

Foreign Denominated or Domiciled Senior Loans
and Foreign Corporate Bonds & Notes
Industry Concentration Table:

(% of Net Assets)

 

Service

    0.8

Energy

    0.2

Healthcare

    0.1

Media & Telecommunications

    0.0 %(1) 

Retail

    0.0 %(1) 
 

 

 

 

Total

    1.1
 

 

 

 

 

(1) 

Less than 0.05%

 

 

See accompanying Notes to Financial Statements.       11


Table of Contents

STATEMENT OF ASSETS AND LIABILITIES

 

As of December 31, 2014   NexPoint Credit Strategies Fund
      ($)  

Assets

  

Investments from unaffiliated issuers, at value (cost $1,149,662,032)

     1,013,845,207   

Affiliated issuers, at value (cost $309,041,225) (Note 11)

     298,651,940   
  

 

 

 

Total Investments, at value (cost $1,458,703,257)

     1,312,497,147   

Foreign currency (cost $2,224,287)

     2,157,600   

Receivable for:

  

Investments sold

     46,585,284   

Dividends and interest

     7,192,517   

Other assets

     89,391   
  

 

 

 

Total assets

     1,368,521,939   
  

 

 

 

Liabilities

  

Due to custodian

     11,597,230   

Notes payable (Notes 6 & 7)

     385,336,455   

Securities sold short, at value (proceeds $33,641,632) (Notes 2 and 9)

     32,097,055   

Written options contracts, at value (premiums $1,296,020) (Note 3)

     2,730,400   

Due to broker (Note 2)

     56,853,612   

Payable for:

  

Investments purchased

     17,073,549   

Investment advisory and administration fees (Note 8)

     1,089,892   

Trustees’ fees (Note 8)

     27,374   

Interest expense (Note 6)

     414,014   

Accrued expenses and other liabilities

     424,961   
  

 

 

 

Total liabilities

     507,644,542   
  

 

 

 

Net Assets Applicable to Common Shares

     860,877,397   
  

 

 

 

Net Assets Consist of:

  

Par value of common shares (Note 1)

     63,881   

Paid-in capital in excess of par value of common shares

     1,138,318,778   

Undistributed net investment income

     17,839,665   

Accumulated net realized loss from investments, securities sold short, forward foreign currency exchange contracts and foreign currency transactions

     (149,136,076

Net unrealized depreciation on investments, securities sold short, written options contracts, forward foreign currency exchange contracts and translation of assets and liabilities denominated in foreign currency

     (146,208,851
  

 

 

 

Net Assets Applicable to Common Shares

     860,877,397   
  

 

 

 

Common Shares

  

Net assets

     860,877,397   

Shares outstanding (unlimited authorization)

     63,881,473   

Net asset value per share (Net assets/shares outstanding)

     13.48   

 

12       See accompanying Notes to Financial Statements.


Table of Contents

STATEMENT OF OPERATIONS

 

For the Year Ended December 31, 2014   NexPoint Credit Strategies Fund
     ($)  

Investment Income

 

Dividends from unaffiliated issuers

    42,485,808   

Dividends from affiliated issuers (Note 11)

    426,000   

Less: Foreign taxes withheld

    (47,857

Securities lending income (Note 4)

    137,980   

Interest from unaffiliated issuers

    29,833,960   

Other income

    39,628   
 

 

 

 

Total Investment Income

    72,875,519   
 

 

 

 

Expenses:

 

Investment advisory (Note 8)

    12,038,416   

Administration fees (Note 8)

    2,421,464   

Transfer agent fees

    65,801   

Trustees’ fees (Note 8)

    115,124   

Accounting service fees

    262,252   

Audit fees

    224,211   

Registration fees

    119,956   

Insurance expense

    123,606   

Reports to shareholders

    226,061   

Interest expense (Note 6)

    4,070,500   

Dividends and expenses on securities sold short (Note 2)

    539,035   

Other expenses

    12,979   
 

 

 

 

Total operating expenses

    20,219,405   
 

 

 

 

Net investment income

    52,656,114   
 

 

 

 

Net Realized and Unrealized Gain/(Loss) on Investments:

 

Net realized gain/(loss) on Investments from unaffiliated issuers

    252,170,575   

Net realized gain/(loss) on Investments from affiliated issuers (Note 11)

    (25

Net realized gain/(loss) on securities sold short (Note 2)

    (13,300,407

Net realized gain/(loss) on forward foreign currency exchange contracts (Note 3)

    (125,480

Net realized gain/(loss) on foreign currency transactions

    8,895   

Net change in unrealized appreciation/(depreciation) on investments

    (122,050,265

Net change in unrealized appreciation/(depreciation) on securities sold short (Note 2)

    12,745,621   

Net change in unrealized appreciation/(depreciation) on written options (Note 3)

    (1,434,380

Net change in unrealized appreciation/(depreciation) on forward foreign currency exchange contracts (Note 3)

    240,356   

Net change in unrealized appreciation/(depreciation) on translation of assets and liabilities denominated in foreign currency

    (120,979
 

 

 

 

Net realized and unrealized gain/(loss) on investments

    128,133,911   
 

 

 

 

Net increase in net assets resulting from operations

    180,790,025   
 

 

 

 

 

See accompanying Notes to Financial Statements.       13


Table of Contents

STATEMENTS OF CHANGES IN NET ASSETS

 

  NexPoint Credit Strategies Fund
     Year Ended
December 31, 2014
($)
     Year Ended
December 31, 2013
($)
 

From Operations

     

Net investment income

     52,656,114         39,556,073   

Net realized gain on investments, securities sold short, forward foreign currency exchange contracts and foreign currency transactions

     238,753,558         78,104,379   

Net change in unrealized appreciation/ (depreciation) on investments, securities sold short, written options contracts, forward foreign currency exchange contracts and translation of assets and liabilities denominated in foreign currency

     (110,619,647      165,632,087   
  

 

 

    

 

 

 

Net change in net assets from operations

     180,790,025         283,292,539   
  

 

 

    

 

 

 

Distributions Declared to Common Shareholders

     

From net investment income

     (44,397,624      (35,070,929
  

 

 

    

 

 

 

Total distributions declared to common shareholders

     (44,397,624      (35,070,929
  

 

 

    

 

 

 

Total increase in net assets from common shares

     136,392,401         248,221,610   
  

 

 

    

 

 

 

Net Assets Applicable to Common Shareholders

     

Beginning of period

     724,484,996         476,263,386   
  

 

 

    

 

 

 

End of period (including undistributed net investment income of $17,839,665 and $6,414,491 respectively)

     860,877,397         724,484,996   
  

 

 

    

 

 

 

Change in Common Shares

     

Net increase (decrease) in common shares

               
  

 

 

    

 

 

 

 

14       See accompanying Notes to Financial Statements.


Table of Contents

 

STATEMENT OF CASH FLOWS

 

For the Year Ended December 31, 2014   NexPoint Credit Strategies Fund
      ($)  

Cash Flows Used in Operating Activities

  

Net increase in net assets from operations

     180,790,025   

Adjustments to Reconcile Net Investment Income to Net Cash Used in Operating Activities

  

Purchases of investment securities from unaffiliated issuers

     (1,027,176,487

Proceeds from disposition of investment securities from unaffiliated issuers

     946,987,861   

Purchases of purchased options

     (32,807,199

Purchases of securities sold short

     (114,686,665

Proceeds from securities sold short

     53,525,162   

Paydowns at cost

     5,662,883   

Net accretion of discount

     (7,059,209

Net premium received on open written options contracts

     2,872,273   

Net realized gain on investments from unaffiliated issuers

     (252,170,575

Net realized loss on investments from affiliated issuers

     25   

Net realized loss on securities sold short, forward foreign currency exchange contracts and foreign currency transactions

     13,416,992   

Net change in unrealized appreciation/(depreciation) on investments, securities sold short, written options contracts, forward foreign currency exchange contracts and translation of assets and liabilities denominated in foreign currency

     110,619,647   

Net change in short-term investments

     1,919,814   

Decrease in receivable for restricted cash — securities sold short

     75,438,228   

Increase in receivable for investments sold

     (45,130,021

Decrease in receivable for dividends and interest

     2,202,106   

Increase in other assets

     (3,176

Increase in payable for investments purchased

     11,965,757   

Decrease in payable upon receipt of securities on loan

     (1,919,814

Increase in payables to related parties

     114,572   

Increase in payable for Due to broker

     56,853,612   

Increase in payable for interest expense

     119,219   

Decrease in accrued expenses and other liabilities

     (191,780
  

 

 

 

Net cash flow used in operating activities

     (18,656,750
  

 

 

 

Cash Flows Provided by Financing Activities

  

Increase in notes payable

     66,836,455   

Distributions paid in cash

     (44,397,624
  

 

 

 

Net cash flow provided by financing activities

     22,438,831   
  

 

 

 

Effect of exchange rate changes on cash

     (237,564
  

 

 

 

Net increase in cash

     3,544,517   
  

 

 

 

Cash & Foreign Currency/Due to Custodian

  

Beginning of the year

     (12,984,147
  

 

 

 

End of the year

     (9,439,630
  

 

 

 

Supplemental disclosure of cash flow information:

  

Cash paid during the year for interest

     3,951,281   
  

 

 

 

 

See accompanying Notes to Financial Statements.       15


Table of Contents

FINANCIAL HIGHLIGHTS

 

  NexPoint Credit Strategies Fund

Selected data for a share outstanding throughout each period is as follows:

 

     For the Years Ended December 31,  
Common Shares Per Share Operating Performance:    2014      2013      2012      2011      2010  

Net Asset Value, Beginning of Period

   $ 11.34       $ 7.46       $ 6.94       $ 7.72       $ 7.20   

Income from Investment Operations:

              

Net investment income

     0.82         0.63         0.43         0.47         0.59   

Net realized and unrealized gain/(loss)

     2.02         3.80         0.52         (0.72      0.56   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total from investment operations

     2.84         4.43         0.95         (0.25      1.15   

Less Distributions Declared to Common Shareholders:

              

From net investment income

     (0.70      (0.55      (0.43      (0.53      (0.63
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total distributions declared to common shareholders

     (0.70      (0.55      (0.43      (0.53      (0.63

Net Asset Value, End of Period

   $ 13.48       $ 11.34       $ 7.46       $ 6.94       $ 7.72   

Market Value, End of Period

   $ 11.23       $ 9.42       $ 6.64       $ 6.18       $ 7.58   

Market Value Total Return(a)

     26.77      52.03      14.73      (12.18 )%       30.76

Ratios and Supplemental Data:

              

Net assets, end of period (in 000’s)

   $   860,877       $   724,485       $   476,263       $   443,048       $   492,753   

Common Share Information at End of Period:

              

Ratios based on average net assets of common shares:

              

Gross operating expenses(b)(c)

     2.48      2.82      3.14      3.15      3.14

Fees and expenses waived

     N/A         N/A         N/A         N/A         (0.14 )% 

Net operating expenses(b)

     2.48      2.82      3.14      3.15      3.00

Net investment income

     6.45      7.01      6.00      6.24      7.92

Ratios based on managed net assets of common shares:

              

Gross operating expenses(b)(d)

     1.68      1.98      2.26      2.27      2.51

Fees and expenses waived

     N/A         N/A         N/A         N/A         (0.11 )% 

Net operating expenses(b)

     1.68      1.98      2.26      2.27      2.40

Net investment income

     4.38      4.91      4.32      4.50      6.34

Portfolio turnover rate

     59      74      92      52      91

 

(a) Based on market value per share. Distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the Fund’s Dividend Reinvestment Plan.
(b) Includes dividends and expenses on securities sold short.
(c) Gross operating expenses (excluding interest expense and commitment fees) were 1.98%, 2.22%, 2.22%, 2.23% and 2.13% for the years ended December 31, 2014, 2013, 2012, 2011 and 2010, respectively.
(d) Gross operating expenses (excluding interest expense and commitment fees) were 1.34%, 1.56%, 1.60%, 1.61% and 1.70% for the years ended December 31, 2014, 2013, 2012, 2011 and 2010, respectively.

 

16       See accompanying Notes to Financial Statements.


Table of Contents

NOTES TO FINANCIAL STATEMENTS

 

December 31, 2014   NexPoint Credit Strategies Fund

Note 1. Organization

NexPoint Credit Strategies Fund (the “Fund”) is a Delaware statutory trust and is registered with the Securities and Exchange Commission (the “SEC”) under the Investment Company Act of 1940, as amended (the “1940 Act”), as a non-diversified, closed-end management investment company. The financial statements include information for the fiscal year ended December 31, 2014. The Fund trades on the New York Stock Exchange (“NYSE”) under the ticker symbol NHF. The Fund may issue an unlimited number of common shares, par value $0.001 per share (“Common Shares”). The Fund commenced operations on June 29, 2006. NexPoint Advisors, L.P. (“NexPoint”) or “Investment Advisor”, an affiliate of Highland Capital Management Fund Advisors, L.P. (“Highland”), is the investment advisor and administrator to the Fund.

Note 2. Significant Accounting Policies

The following summarizes the significant accounting policies consistently followed by the Fund in the preparation of its financial statements.

Use of Estimates

The Fund is an investment company that follows the accounting and reporting guidance of Accounting Standards Codification Topic 946 applicable to investment companies. The Fund’s financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ materially.

Fund Valuation

The net asset value (“NAV”) of the Fund’s common shares is calculated daily on each day that the NYSE is open for business as of the close of the regular trading session on the NYSE, usually 4:00 PM, Eastern Time. The NAV is calculated by dividing the value of the Fund’s net assets attributable to common shares by the numbers of common shares outstanding.

Valuation of Investments

In computing the Fund’s net assets attributable to common shares, securities with readily available market quotations on the NYSE, NASDAQ or other nationally recognized exchange, use the closing quotations on the respective

exchange for valuation of those securities. Securities for which there are no readily available market quotations will be valued pursuant to policies adopted by the Board of Trustees. Typically, such securities will be valued at the mean between the most recently quoted bid and ask prices provided by the principal market makers. If there is more than one such principal market maker, the value shall be the average of such means. Securities without a sale price or quotations from principal market makers on the valuation day may be priced by an independent pricing service. Generally, the Fund’s loan and bond positions are not traded on exchanges and consequently are valued based on a mean of the bid and ask price from the third-party pricing services or broker-dealer sources determined to generally have the capability to provide appropriate pricing services and have been approved by the Trustees.

Securities for which market quotations are not readily available, for which the Fund has determined the price received from a pricing service or broker-dealer is “stale” or otherwise does not represent fair value (such as when events materially affecting the value of securities occur between the time when market price is determined and calculation of the Fund’s NAV), will be valued by the Fund at fair value, as determined by the Board or its designee in good faith in accordance with procedures approved by the Board, taking into account factors reasonably determined to be relevant, including, among other things,: (i) the fundamental analytical data relating to the investment; (ii) the nature and duration of restrictions on disposition of the securities; and (iii) an evaluation of the forces that influence the market in which these securities are purchased and sold. In these cases, the Fund’s NAV will reflect the affected portfolio securities’ fair value as determined in the judgment of the Board or its designee instead of being determined by the market. Using a fair value pricing methodology to value securities may result in a value that is different from a security’s most recent sale price and from the prices used by other investment companies to calculate their NAV. Determination of fair value is uncertain because it involves subjective judgments and estimates.

There can be no assurance that the Fund’s valuation of a security will not differ from the amount that it realizes upon the sale of such security. Those differences could have a material impact to the Fund.

Fair Value Measurements

The Fund has performed an analysis of all existing investments and derivative instruments to determine the significance and character of all inputs to their fair value determination. The levels of fair value inputs used to measure the Fund’s investments are characterized into a fair value hierarchy. Where inputs for an asset or liability

 

 

Annual Report       17


Table of Contents

NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

fall into more than one level in the fair value hierarchy, the investment is classified in its entirety based on the lowest level input that is significant to that investment’s valuation. The three levels of the fair value hierarchy are described below:

 

Level 1 — Quoted unadjusted prices for identical instruments in active markets to which the Fund has access at the date of measurement;

 

Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active, but are valued based on executed trades; broker quotations that constitute an executable price; and alternative pricing sources supported by observable inputs are classified within Level 2. Level 2 inputs are either directly or indirectly observable for the asset in connection with market data at the measurement date; and

 

Level 3 — Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. In certain cases, investments classified within Level 3 may include securities for which the Fund has obtained indicative quotes from broker-dealers that do not necessarily represent prices the broker may be willing to trade on, as such quotes can be subject to material management judgment. Unobservable inputs are those inputs that reflect the Fund’s own assumptions that market participants would use to price the asset or liability based on the best available information.

The Investment Adviser has established policies, as described above and approved by the Board, to ensure that valuation methodologies for investments and financial instruments that are categorized within all levels of the fair value hierarchy are fair and consistent. A Pricing Committee has been established to provide oversight of the valuation policies, processes and procedures, and is comprised of personnel from the Investment Adviser. The Pricing Committee meets monthly to review the proposed valuations for investments and financial instruments and is responsible for evaluating the overall fairness and consistent application of those policies.

As of December 31, 2014, the Fund’s investments consisted of senior loans, asset-backed securities, corporate bonds and notes, common stocks, preferred stocks, exchange-traded funds, warrants, securities sold short and options. The fair value of the Fund’s loans, bonds and asset-backed securities are generally based on quotes received from brokers or independent pricing services. Loans, bonds and

asset-backed securities with quotes that are based on actual trades with a sufficient level of activity on or near the measurement date are classified as Level 2 assets. Loans, bonds and asset-backed securities that are priced using quotes derived from implied values, indicative bids, or a limited number of actual trades are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not readily observable.

The fair value of the Fund’s common stocks, preferred stocks, warrants and options that are not actively traded on national exchanges are generally priced using quotes derived from implied values, indicative bids, or a limited amount of actual trades and are classified as Level 3 assets because the inputs used by the brokers and pricing services to derive the values are not readily observable. The Fund’s real estate investments include equity interests in limited liability companies and equity issued by REITs that invest in commercial real estate. The fair value of real estate investments that are not actively traded on national exchanges are based on internal models developed by the Investment Advisor. The significant inputs to the models include cash flow projections for the underlying properties, capitalization rates and appraisals performed by independent valuation firms. These inputs are not readily observable, and the Fund has classified the investments as Level 3 assets. Exchange traded options are valued based on the last trade price on the primary exchange on which they trade. If an option does not trade, the mid-price is utilized to value the option.

At the end of each calendar quarter, management evaluates the Level 2 and 3 assets and liabilities for changes in liquidity, including but not limited to: whether a broker is willing to execute at the quoted price, the depth and consistency of prices from third party services, and the existence of contemporaneous, observable trades in the market. Additionally, management evaluates the Level 1 and 2 assets and liabilities on a quarterly basis for changes in listings or delistings on national exchanges.

Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Fund’s investments may fluctuate from period to period. Additionally, the fair value of investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values the Fund may ultimately realize. Further, such investments may be subject to legal and other restrictions on resale or otherwise less liquid than publicly traded securities.

 

 

18       Annual Report


Table of Contents

NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. Transfers in and out of the levels are recognized at the value at the end of the period. A summary of the inputs used to value the Fund’s assets as of December 31, 2014 is as follows:

 

 

       

Total value at

December 31, 2014

      

Level 1

Quoted

Price

      

Level 2

Significant

Observable

Inputs

      

Level 3

Significant

Unobservable

Inputs

 

NexPoint Credit Strategies Fund

                   

Assets

                   

U.S. Senior Loans

                   

Broadcasting

     $ 29,151,613         $         $ 29,151,613         $   

Gaming & Leisure

       4,840,721                     244,129           4,596,592   

Healthcare

       2,150,625                               2,150,625   

Housing

       72,857                               72,857   

Media & Telecommunications

                                     (2) 

Service

       11,470,195                     11,470,195             

Telecommunications

       6,637,538                               6,637,538   

Utility

       41,795,436                     33,911,441           7,883,995   

Foreign Denominated or Domiciled Senior Loans(1)

       4,307,312                     3,924,100           383,212   

Asset-Backed Securities

       130,571,560                     130,571,560             

Corporate Bonds & Notes(1)

       54,181,381                     54,181,381             

Foreign Corporate Bonds & Notes(1)

       5,004,491                     4,359,340           645,151   

Sovereign Bonds

       74,571,093                     74,571,093             

Common Stocks & Exchange-Traded Funds

                   

Broadcasting

       2,826,747                               2,826,747   

Consumer Discretionary

       138,859,729           138,859,729                       

Consumer Staples

       189,952           189,952                       

Energy

       65,620,013           65,620,013                       

Financial

       18,009,868           10,724,774                     7,285,094   

Gaming & Leisure

                                     (2) 

Healthcare

       8,791,130           5,361,530                     3,429,600   

Housing

       1,239,193                               1,239,193   

Information Technology

       52,887,467           52,887,467                       

Media & Telecommunications

       113,029,514           85,933,086           23,011,187           4,085,241   

Metals & Minerals

       22,406,638           22,406,638                       

Real Estate

       3                               3   

Real Estate Investment Trust

       307,695,451           13,673,821                     294,021,630   

Telecommunications

       12,325,733                               12,325,733   

Utility

       39,143,057           31,619,438           7,523,619             

Wireless Communications

       3,119,530           3,119,530                       

Preferred Stocks(1)

       139,989,850                     139,989,850             

Warrants(1)

                   

Equity Contracts

                                     (2) 

Purchased Call Options

       21,608,450           21,608,450                       
    

 

 

      

 

 

      

 

 

      

 

 

 

Total Assets

       1,312,497,147           452,004,428           512,909,508           347,583,211   
    

 

 

      

 

 

      

 

 

      

 

 

 

Liabilities

                   

Securities Sold Short(1)

       (32,097,055        (32,097,055                    

Written Put Options

       (2,730,400        (2,730,400                    
    

 

 

      

 

 

      

 

 

      

 

 

 

Total Liabilities

       (34,827,455        (34,827,455                    
    

 

 

      

 

 

      

 

 

      

 

 

 

Total

     $ 1,277,669,692         $ 417,176,973         $ 512,909,508         $ 347,583,211   
    

 

 

      

 

 

      

 

 

      

 

 

 

 

(1)

See Investment Portfolio detail for industry/country breakout.

(2)

This category includes securities with a value of zero.

 

Annual Report       19


Table of Contents

NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

The table below sets forth a summary of changes in the Fund’s Level 3 assets (assets measured at fair value using significant unobservable inputs) for the year ended December 31, 2014.

 

     Balance
as of
December 31,
2013
    Transfers
into
Level 3
    Transfers
Out
of Level 3
    Net
Amortization
(Accretion)
of Premium/
(Discount)
    Net
Realized
Gains/
(Losses)
    Net
Unrealized
Gains/
(Losses)
    Net
Purchases
(1)
    Net
(Sales)
(1)
    Balance
as of
December 31,
2014
    Change in
Unrealized
Gain/(Loss)
on Level 3
securities
still held at
period end
 

U.S. Senior Loans

  

                 

Broadcasting

  $ 35,809,838      $      $ (29,151,613   $ (12,397   $      $ 152,602      $      $ (6,798,430   $      $   

Forest Products & Containers

    205,250                      117        7,826        (7,943            (205,250              

Gaming & Leisure

    3,519,782                                    669,704        407,106               4,596,592        669,704   

Healthcare

                                       (47,175     2,197,800               2,150,625        (47,175

Housing

    189,410                             49,393        (112,004            (53,942     72,857        (112,004

Media & Telecommuni- cations(2)

    902,477                      (787,564     (9,031,187     9,366,201        7,377,561        (1,189,950     6,637,538        191,199   

Service

    504,375                                    (6,875            (497,500              

Utility

    1,133,438                      33,824        216,352        302,450        10,097,084        (3,899,153     7,883,995        327,762   

Foreign Denominated or Domiciled Senior Loans(2)

    462,633                      391        34,107        10,499               (124,418     383,212        10,499   

Asset-Backed Securities

    15,561,628                      233,346        2,257,260        (1,932,584            (16,119,650              

Corporate Bonds & Notes(3)

                   

Healthcare

    1,379,833                             (5,340,219     5,714,875               (1,754,489              

Foreign Corporate Bonds & Notes(3)

                   

Healthcare

    2,367,703                                    (1,722,552                   645,151        (1,722,552

Common Stocks & Exchange-Traded Funds

                   

Broadcasting

    16,084,928                             10,461,788        (1,758,656            (21,961,313     2,826,747        2,826,747   

Financial

    342,517                             (25     730,492        18,962,085        (12,749,975     7,285,094        730,492   

Gaming & Leisure

                                       6,560,773               (6,560,773            6,560,773   

Healthcare

    13,992,000                                    (10,562,400                   3,429,600        (10,562,400

Housing

    1,126,539                                    112,654                      1,239,193        112,654   

Media & Telecommuni- cations

                                       (1,674,099     5,759,340               4,085,241        (1,674,099

Real Estate

                                       (1,933,551     3,120,844        (1,187,290     3        (1,933,551

Real Estate Investment Trust

    42,964,014                                    43,074,333        207,983,283               294,021,630        43,074,333   

Telecommunications

                                              12,325,733               12,325,733          

Preferred Stocks

                   

Financial

    14,218,831               (25,797,250                   (6,742,831     18,321,250                        

Warrants

                   

Equity Contracts

                                                                     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 150,765,196      $     —      $ (54,948,863   $ (532,283   $ (1,344,705   $ 40,193,913      $ 286,552,086      $ (73,102,133   $ 347,583,211      $ 38,452,382   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Includes any applicable borrowings and/or paydowns made on revolving credit facilities held in the Fund’s Investment Portfolio.

(2) 

Balance as of December 31, 2013 reflects a sector reclassification for Aufinco Pty, Ltd. from U.S. Senior Loans to Foreign Denominated or Domiciled Senior Loans.

 

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NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund
(3) 

Balance as of December 31, 2013 reflects a sector reclassification for Celtic Pharma Phinco BV from Corporate Bonds & Notes to Foreign Corporate Bonds & Notes.

 

Investments designated as Level 3 may include assets valued using quotes or indications furnished by brokers which are based on models or estimates and may not be executable prices. In light of the developing market conditions, the Investment Adviser continues to search for observable data points and evaluate broker quotes and indications received for portfolio investments. As a result, for the year ended December 31, 2014, a net amount of $54,948,863 of the Fund’s portfolio investments were

transferred between Level 2 and Level 3. Determination of fair values is uncertain because it involves subjective judgments and estimates that are unobservable. Transfers from Level 3 to Level 2 are due to an increase in market activity (e.g. frequency of trades), which resulted in an increase of available market inputs to determine price.

For the year ended December 31, 2014, there were no transfers between Level 1 and Level 2.

 

 

The following table summarizes the valuation techniques used and unobservable inputs developed to determine the fair value of material Level 3 investments:

 

Fund and
Category
  Ending
Balance at
12/31/14
    Valuation Technique   Unobservable Inputs   Input Value(s)

NexPoint Credit Strategies Fund

       

Debt

  $ 22,369,970      Third-Party Pricing Vendor   N/A   N/A
    Multiples Analysis   Liquidity Discount   10%
    Liquidation Analysis   Settlement Discount   30%
    Sales Analysis   N/A   N/A

Common Stocks

    31,191,611      Multiples Analysis   Multiple of EBITDA   7.5x
      Liquidity Discount   15% - 25%
      Minority Discount   20%
      Regional Market Appreciation   35% - 39%
    Third-Party Pricing Vendor   N/A   N/A
    Sales Analysis   N/A   N/A
    Discounted Cash Flows   Discount Rate   21%
    Recovery Analysis   Scenario Probabilities   Various
    Escrow Analysis   Discount Rate   20%

Real Estate Investment Trust

  $ 294,021,630      Fair Valuation-Multiple Methodologies(1)   Capitalization Rates   5.8% - 7.6%
    Net Asset Value of Underlying Assets   N/A   N/A
 

 

 

       

Total

  $ 347,583,211         

 

(1)

Methodologies consist of the Income Approach, Market Approach and Cost Approach.

 

The significant unobservable inputs used in the fair value measurement of the Fund’s debt investments are discount rates, liquidity discounts and settlement discounts. Significant increases or decreases in either of those inputs in isolation would result in a significantly lower or higher fair value measurement.

The significant unobservable inputs used in the fair value measurement of the reporting entity’s common stock investments are discount rates, scenario probabilities, liquidity discounts, minority discounts, multiple of EBITDA and regional market appreciation. Significant changes in either of those inputs in isolation would result in a significantly lower or higher fair value measurement.

The significant unobservable inputs used in the fair value measurement of the reporting entity’s real estate trust investments are capitalization rates. Significant changes in either of those inputs in isolation would result in a significantly lower or higher fair value measurement.

Security Transactions

Security transactions are accounted for on the trade date. Realized gains/(losses) on investments sold are recorded on the basis of specific identification method for both financial statement and U.S. federal income tax purposes.

 

 

Annual Report       21


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NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

Income Recognition

Corporate actions (including cash dividends) are recorded on the ex-dividend date, net of applicable withholding taxes, except for certain foreign corporate actions, which are recorded as soon after ex-dividend date as such information becomes available. Interest income is recorded on the accrual basis.

Accretion of discount and amortization of premium on taxable bonds are computed to the call or maturity date, whichever is shorter, using the effective yield method. Withholding taxes on foreign dividends have been provided for in accordance with the Fund’s understanding of the applicable country’s tax rules and rates.

U.S. Federal Income Tax Status

The Fund is treated as a separate taxpayer for U.S. federal income tax purposes. The Fund intends to qualify each year as a “regulated investment company” under Subchapter M of the Internal Revenue Code of 1986, as amended, and will distribute substantially all of its taxable income and gains, if any, for the tax year, and as such will not be subject to U.S. federal income taxes.

Management has analyzed the Fund’s tax positions taken on U.S. federal income tax returns for all open tax years (current and prior three tax years), and has concluded that no provision for U.S. federal income tax is required in the Fund’s financial statements. The Fund’s U.S. federal and state income and U.S. federal excise tax returns for tax years for which the applicable statutes of limitations have not expired are subject to examination by the Internal Revenue Service and state departments of revenue. Furthermore, management of the Fund, is also not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly change in the next 12 months.

Distributions to Shareholders

The Fund plans to pay distributions from net investment income monthly and net realized capital gains annually to common shareholders. To permit the Fund to maintain more stable monthly distributions and annual distributions, the Fund may from time to time distribute less than the entire amount of income and gains earned in the relevant month or year, respectively. The undistributed income and gains would be available to supplement future distributions. Shareholders of the Fund will automatically have all distributions reinvested in Common Shares of the Fund issued by the Fund or purchased in the open market in accordance with the Fund’s Dividend Reinvestment Plan (the “Plan”) unless an election is made to receive cash. Each participant in the Plan will pay a pro rata share of brokerage commissions incurred in connection with open market

purchases, and participants requesting a sale of securities through the plan agent of the Plan are subject to a sales fee and a brokerage commission.

Statement of Cash Flows

Information on financial transactions which have been settled through the receipt or disbursement of cash is presented in the Statement of Cash Flows. The cash amount shown in the Statement of Cash Flows is the amount included within the Fund’s Statement of Assets and Liabilities and includes cash on hand at its custodian bank and sub-custodian bank, and does not include cash posted as collateral in the segregated account or with the broker-dealers.

Cash & Cash Equivalents

The Fund considers liquid assets deposited with a bank and certain short-term debt instruments with original maturities of 3 months or less to be cash equivalents. These investments represent amounts held with financial institutions that are readily accessible to pay Fund expenses or purchase investments. Cash and cash equivalents are valued at cost plus accrued interest, which approximates market value. The value of cash equivalents denominated in foreign currencies is determined by converting to U.S. dollars on the date of the Statement of Assets and Liabilities.

Foreign Currency

Accounting records of the Fund are maintained in U.S. dollars. Foreign currencies, investments and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates using the current 4:00 PM London Time Spot Rate. Fluctuations in the value of the foreign currencies and other assets and liabilities resulting from changes in exchange rates, between trade and settlement dates on securities transactions and between the accrual and payment dates on dividends, interest income and foreign withholding taxes, are recorded as unrealized foreign currency gains/(losses). Realized gains/(losses) and unrealized appreciation/(depreciation) on investment securities and income and expenses are translated on the respective dates of such transactions. The effects of changes in foreign currency exchange rates on investments in securities are not segregated in the Statement of Operations from the effects of changes in market prices of those securities, but are included with the net realized and unrealized gain or loss on investment securities.

Securities Sold Short

The Fund may sell securities short. A security sold short is a transaction in which the Fund sells a security it does not

 

 

22       Annual Report


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NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

own in anticipation that the market price of that security will decline. When the Fund sells a security short, it must borrow the security sold short from a broker-dealer and deliver it to the buyer upon conclusion of the transaction. The Fund may have to pay a fee to borrow particular securities and is often obligated to pay over any dividends or other payments received on such borrowed securities. Cash held as collateral for securities sold short is classified as restricted cash on the Statement of Assets and Liabilities. Securities held as collateral for securities sold short are shown on the Investment Portfolio for the Fund.

When securities are sold short, the Fund intends to limit exposure to a possible market decline in the value of its portfolio securities through short sales of securities that the Investment Adviser believes possess volatility characteristics similar to those being hedged. In addition, the Fund may use short sales for non-hedging purposes to pursue its investment objective. Subject to the requirements of the 1940 Act and the Internal Revenue Code of 1986, as amended (the “Code”), the Fund will not make a short sale if, after giving effect to such sale, the market value of all securities sold short by the Fund exceeds 25% of the value of its total assets.

Note 3. Derivative Transactions

The Fund is subject to equity price risk, interest rate risk and foreign currency exchange rate risk in the normal course of pursuing its investment objective. The Fund enters into derivative transactions for the purpose of hedging against the effects of changes in the value of portfolio securities due to anticipated changes in market conditions, to gain market exposure for residual and accumulating cash positions and for managing the duration of fixed income investments.

Forward Foreign Currency Exchange Contracts

The Fund enters into forward foreign currency exchange contracts to facilitate transactions in foreign denominated securities and to manage the Fund’s currency exposure. A forward contract represents a commitment for the future purchase or sale of an asset at a specified price on a specified date. Upon entering into such contracts, daily fluctuations in the value of the contract are recorded for financial statement purposes as unrealized gains or losses by the Fund. At the expiration of the contracts, the Fund realizes the gain or loss. Forward foreign currency exchange contracts are valued at the mean between the bid and the offered forward rates as last quoted by a recognized dealer. The aggregate principal amounts of the contracts are not recorded in the Fund’s financial statements. Such amounts appear under the caption Forward Foreign Currency Exchange Contracts in the Investment Portfolio.

Fluctuations in the value of the contracts are recorded in the Statement of Assets and Liabilities as an asset (or liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized gains or losses on foreign currency related transactions. The Fund’s risks in using these contracts include changes in the value of foreign currency or the possibility that the counterparties do not perform under the contracts’ terms. When the Fund enters into a forward foreign currency exchange contract, it is required to segregate cash or liquid securities with its custodian in an amount equal to the value of the Fund’s total assets committed to the consummation of the forward contract. If the value of the segregated securities declines, additional cash or securities are segregated so that the value of the account will equal the amount of the Fund’s commitment with respect to the contract. The Fund invested in forward foreign currency exchange contracts during the year, however, none were held as of December 31, 2014.

Options

The Fund purchases and writes options, subject to certain limitations. The Fund may invest in options contracts to manage its exposure to the stock and bond markets and fluctuations in foreign currency values. Writing puts and buying calls tend to increase the Fund’s exposure to the underlying instrument while buying puts and writing calls tend to decrease the Fund’s exposure to the underlying instrument, or economically hedge other Fund investments. The Fund’s risks in using these contracts include changes in the value of the underlying instruments, nonperformance of the counterparties under the contracts’ terms and changes in the liquidity of the secondary market for the contracts. Options are valued at the last sale price, or if no sales occurred on that day, at the last quoted bid price.

When the Fund writes an option, the amount of the premium received is recorded as a liability and is subsequently adjusted to the current fair value of the option written. Premiums received from writing options that expire unexercised are treated by the Fund on the expiration date as realized gains from investments. The difference between the premium and the amount paid on effecting a closing purchase transaction, including brokerage commissions, is also treated as a realized gain, or if the premium is less than the amount paid for the closing purchase, as a realized loss. When an option is exercised, the proceeds from the sale of the underlying security or the cost basis of the securities purchased are adjusted by the original premium received or paid.

 

 

Annual Report       23


Table of Contents

NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

Transactions in written options for the year ended December 31, 2014:

 

     Number of
Contracts
    Premium  

Outstanding, December 31, 2013

         $   

Put Options Written

    10,050        2,872,273   

Put Options Exercised

    (5,000     (1,576,253

Outstanding, December 31, 2014

    5,050        1,296,020   

Additional Derivative Information

The Fund adopted amendments to authoritative guidance on disclosures about derivative instruments and hedging activities which require that the Fund disclose: a) how and why an entity uses derivative instruments, b) how derivative instruments and related hedged items are accounted for, c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows and d) how the netting of derivatives subject to master netting arrangements affects the net exposure of the Fund related to the derivatives.

The fair value of derivative instruments on the Statement of Assets and Liabilities have the following risk exposure at December 31, 2014:

 

   

Fair Value

 
Risk Exposure   Asset
Derivative
    Liability
Derivative
 

Equity Price Risk

  $ 21,608,450 (1)    $ (2,730,400 )(2) 

 

(1)

Statement of Assets and Liabilities location: Investments from unaffiliated issuers, at value.

(2)

Statement of Assets and Liabilities location: Written options contracts, at value.

The effect of derivative instruments on the Statement of Operations for the year ended December 31, 2014, is as follows:

 

Risk Exposure    Net
Realized
Gain/(Loss)
on
Derivatives
    Net Change in
Unrealized
Appreciation/
(Depreciation)
on  Derivatives
 

Equity Price Risk

   $ (2,417,707 )(1)    $ 1,780,322 (2)(3) 

Foreign Currency Risk

     (125,480 )(4)      240,356 (5) 

 

(1)

Statement of Operations location: Realized gain (loss) on Investments from unaffiliated issuers.

(2)

Statement of Operations location: Net change in unrealized appreciation/(depreciation) on investments from unaffiliated issuers.

(3)

Statement of Operations location: Net change in unrealized appreciation/(depreciation) on written options contracts.

(4)

Statement of Operations location: Realized gain (loss) on forward foreign currency exchange contracts.

(5)

Statement of Operations location: Net change in unrealized appreciation/(depreciation) on forward foreign currency exchange contracts.

The average notional volume of derivative activity for the year ended December 31, 2014, is as follows:

Fund   Units/
Contracts
    Appreciation/
(Depreciation)
 

Purchased Options Contracts

    16,514      $   

Written Options Contracts

    1,010          

Forward Foreign Currency Exchange Contracts

           (56,622

To reduce counterparty credit risk with respect to over-the-counter (“OTC”) transactions, the Fund has entered into master netting arrangements, established within the Fund’s International Swap and Derivatives Association, Inc. (“ISDA”) master agreements, which allows the Fund to make (or to have an entitlement to receive) a single net payment in the event of default (close-out netting) for outstanding payables and receivables with respect to certain OTC derivative positions in forward currency exchange contracts for each individual counterparty. In addition, the Fund may require that certain counterparties post cash and/or securities in collateral accounts to cover its net payment obligations for those derivative contracts subject to ISDA master agreements. If the counterparty fails to perform under these contracts and agreements, the cash and/or securities will be made available to the Fund.

Certain ISDA master agreements include credit related contingent features which allow counterparties to OTC derivatives to terminate derivative contracts prior to maturity in the event the Fund’s net assets decline by a stated percentage or the Fund fails to meet the terms of its ISDA master agreements, which would cause the Fund to accelerate payment of any net liability owed to the counterparty.

For financial reporting purposes, the Fund does not offset derivative assets and derivative liabilities that are subject to netting arrangements in the Statement of Assets and Liabilities. Bankruptcy or insolvency laws of a particular jurisdiction may impose restrictions on or prohibitions against the right of offset in bankruptcy, insolvency or other events.

Collateral terms are contract specific for OTC derivatives. For derivatives traded under an ISDA master agreement, the collateral requirements are typically calculated by netting the mark to market amount for each transaction under such agreement and comparing that to the value of any collateral currently pledged by the Fund or the Counterparty.

For financial reporting purposes, cash collateral that has been pledged to cover obligations of the Fund, if any, is reported in due to/from brokers on the Statement of Assets and Liabilities. Generally, the amount of collateral due from or to a party must exceed a minimum transfer amount threshold before a transfer has to be made. To the extent

 

 

24       Annual Report


Table of Contents

NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

amounts due to the Fund from its counterparties are not fully collateralized, contractually or otherwise, the Fund bears the risk of loss from counterparty non-performance.

The Fund held certain investments during the year with such Master Arrangements; however, none were outstanding at December 31, 2014.

Note 4. Securities Lending

The Fund may make secured loans of its portfolio securities amounting to not more than one-third of the value of its total assets, thereby realizing additional income. The risks in lending portfolio securities, as with other extensions of credit, consist of possible delays in recovery of the securities or possible loss of rights in the collateral should the borrower fail financially and possible investment losses in the investment of collateral. Pursuant to the Fund’s securities lending policy, securities loans are made to borrowers pursuant to agreements requiring that loans be continuously secured by collateral in cash or securities of the U.S. government or its agencies or instrumentalities, irrevocable letters of credit issued by a bank, or forms of collateral acceptable under a Fund’s securities lending agreement, at least equal at all times to the current value of the securities subject to the loan. The borrower pays to the Fund an amount equal to any interest or dividends received on securities subject to the loan. The Fund retains all or a portion of the interest received on investment of the cash collateral or receives a fee from the borrower.

Securities lending transactions are entered into Securities Lending Authorization Agreements (“SLAA”), which provide the right, in the event of default (including bankruptcy or insolvency) for the non-defaulting party to liquidate the collateral and calculate a net exposure to the defaulting party or request additional collateral. In the event that a borrower defaults, the Fund, as lender, would offset the market value of the collateral received against the market value of the securities loaned. The value of the collateral is typically greater than that of the market value of the securities loaned, leaving the lender with a net amount payable to the defaulting party. However, bankruptcy or insolvency laws of a particular jurisdiction may impose restrictions on or prohibitions against such a right of offset in the event of a SLAA counterparty’s bankruptcy or insolvency. Under the SLAA, the Fund can reinvest cash collateral, or, upon an event of default, resell or repledge the collateral, and the borrower can resell or repledge the loaned securities. The risks of securities lending also include the risk that the borrower may not provide additional collateral when required or may not return the securities when due. To mitigate this risk, the Fund benefits from a borrower default indemnity provided by State Street Bank and Trust Company (“State Street”). State Street’s indemnity allows

for full replacement of securities lent. As of December 31, 2014, the Fund did not hold securities on loan.

Note 5. U.S. Federal Income Tax Information

The character of income and gains to be distributed is determined in accordance with income tax regulations which may differ from U.S. GAAP. These differences include (but are not limited to) investments organized as partnerships for tax purposes, foreign taxes, investments in futures, losses deferred to off-setting positions, tax treatment of organizational start-up costs, losses deferred due to wash sale transactions, tax treatment of net investment loss and distributions in excess of net investment income, dividends deemed paid upon shareholder redemption of Fund shares and tax attributes from Fund reorganizations. Reclassifications are made to the Fund’s capital accounts to reflect income and gains available for distribution (or available capital loss carryovers) under income tax regulations. These reclassifications have no impact on net investment income, realized gains or losses, or net asset value of the Fund. The calculation of net investment income per share in the Financial Highlights table excludes these adjustments.

For the year ended December 31, 2014, permanent differences chiefly resulting from foreign currency gains and losses, paydown gains and losses, defaulted bonds, partnership basis adjustments, return of capital distributions from real estate investment trusts and non-deductible excise taxes paid were identified and reclassified among the components of the Fund’s net assets as follows:

 

Undistributed Net
Investment  Income
    Accumulated Net
Realized  Gain/(Loss)
    Paid-in-Capital  
$ 3,166,684      $ (2,022,747   $ (1,143,937

For the year ended December 31, 2014, the Fund’s most recent tax year end, components of distributable earnings on a tax basis are as follows:

 

Undistributed
Ordinary
Income
    Undistributed
Long-Term
Capital Gains
    Other
Temporary
Differences
(1)
    Accumulated
Capital  and
Other Losses
    Net  Tax
Appreciation/
(Depreciation)
(2)
 
$ 20,823,862      $   —      $ (89,122   $ (169,129,683   $ (129,110,319

 

(1) 

Other Temporary Differences is comprised of interfund buy/sell transactions.

(2) 

Any differences between book-basis and tax-basis net unrealized appreciation/(depreciation) are primarily due to deferral of losses from wash sales, non-taxable dividends, partnership, controlled Foreign Corporation and Passive Foreign Investment Company (Qualifying Electing Fund) basis adjustments and defaulted bonds.

 

 

Annual Report       25


Table of Contents

NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

For the year ended December 31, 2014, the Fund had capital loss carryovers as indicated below. The capital loss carryovers are available to offset future realized capital gains to the extent provided in the Code and regulations promulgated thereunder. To the extent that these carryover losses are used to offset future capital gains, it is probable that the gains so offset will not be distributed to shareholders because they would be taxable as ordinary income.

 

2017     2018    

No
Expiration

Short-Term

    No
Expiration
Long-Term
    Total  
$ 123,236,582 (1)    $ 45,893,101 (1)    $   —      $   —      $ 169,129,683   

 

(1) 

The Fund’s ability to utilize the capital loss carryforward may be limited.

 

The tax character of distributions paid during the years ended December 31, 2014 and December 31, 2013 (unless otherwise indicated) is as follows:

 

Distributions Paid From:   2014     2013  

Ordinary Income(1)

  $ 44,397,624      $ 35,070,929   

 

(1)

For tax purposes, short-term capital gains distributions, if any, are considered ordinary income distributions.

Unrealized appreciation and depreciation at December 31, 2014, based on cost of investments for U.S. federal income tax purposes is:

 

Gross
Appreciation
    Gross
Depreciation
    Net
Appreciation/
(Depreciation)
(1)
    Cost  
$ 176,214,935      $ 305,322,513      $ (129,107,578   $ 1,441,604,725   

 

(1) 

Any differences between book-basis and tax-basis net unrealized appreciation/(depreciation) are primarily due to deferral of losses from wash sales, non-taxable dividends, partnership, Controlled Foreign Corporation and Passive Foreign Investment Company (Qualifying Electing Fund) basis adjustments and defaulted bonds.

Qualified Late Year Ordinary and Post October Losses

Under current laws, certain capital losses realized after October 31 may be deferred (and certain ordinary losses after January 1 may be deferred) and treated as occurring on the first day of the following fiscal year. For the fiscal year ended December 31, 2014, the Fund did not elect to defer net realized capital losses incurred from November 1, 2013 through December 31, 2014.

Note 6. Credit Agreement

On February 2, 2011, the Fund entered into a $125,000,000 credit agreement with State Street Bank and Trust Company (the “Credit Agreement”). Concurrent with entering into the Credit Agreement, the Fund agreed to pay a $125,000 structuring fee, which was amortized ratably over the term of the agreement. The terms of the Credit Agreement require the Fund to pay 0.15% on the uncommitted balance and pay a spread of 1.25% over LIBOR on amounts borrowed.

On December 14, 2012, the Fund entered into an amendment (the “Fifth Amendment”) extending the Credit Agreement

termination date from January 31, 2013 to December 13, 2013. Additionally, the spread over LIBOR on amounts borrowed declined from 1.10% to 0.95%. The terms of the Credit Agreement continue to require the Fund to pay 0.15% on the uncommitted balance. On May 9, 2014, the Credit Agreement was increased to $250,000,000, and the termination date was extended to May 8, 2015. As of December 31, 2014, the carrying value of the outstanding debt under the Credit Agreement was $244,000,000 million, excluding accrued interest that was owed at that date. As of December 31, 2014, the fair value of the outstanding Credit Agreement was estimated to be $244,423,878, and would be categorized as Level 3 within the fair value hierarchy. The fair value was estimated based on discounting the cash flows owed using a discount rate of 0.50% over the 4 month risk free rate.

For the year ended December 31, 2014, the average daily note balance was $206,295,890 at a weighted average interest rate of 1.15%, excluding any commitment fee. With respect to the note balance, interest expense of $2,266,626 and uncommitted balance fee of $17,659 are included in interest expense in the Statement of Operations.

On May 16, 2013, the Fund entered into a $125,000,000 Committed Facility Agreement with BNP Paribas Prime Brokerage, Inc. (“BNPP PB, Inc.”) (the “Committed Facility Agreement”). The terms of the Committed Facility Agreement require the Fund to pay 0.55% on the uncommitted balance and pay a spread of 0.75% over the 1-month LIBOR on amounts borrowed. The Fund has the right to terminate the agreement upon 90 days prior notice. On May 29, 2013 the Committed Facility Agreement was amended (the “First Amendment”), increasing from $125,000,000 to $155,000,000. On December 11, 2013 the Committed Facility Agreement was amended (the “Second Amendment”), increasing from $155,000,000 to $175,000,000. On May 6, 2014, the Committed Facility Agreement was amended (the “Third Amendment”), increasing from $175,000,000 to $200,000,000. On October 28, 2014, the Committed Facility Agreement was amended (the “Fourth Amendment”), increasing the number of days prior notice necessary to terminate the agreement from 90 days to 180 days. As of December 31,

 

 

26       Annual Report


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NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

2014, the carrying value of the Committed Facility Agreement was $141,336,455. The fair value of the outstanding Committed Facility Agreement was estimated to be $141,561,148, and would be categorized as Level 3 within the fair value hierarchy. The fair value was estimated based on discounting the cash flows owed using a discount rate of 0.50% over the 90 days risk free rate.

For the year ended December 31, 2014, the average daily note balance was $180,956,337 at a weighted average interest rate of 0.90%, excluding any commitment fee. With respect to the note balance, interest expense of $1,661,411 and uncommitted balance fee of $55,396 are included in interest expense in the Statement of Operations.

Note 7. Asset Coverage

The Fund is required to maintain 300% asset coverage with respect to amounts outstanding under the Credit Agreement and Committed Facility Agreement. Asset coverage is calculated by subtracting the Fund’s total liabilities, not including any amount representing bank loans and senior securities, from the Fund’s total assets and dividing the result by the principal amount of the borrowings outstanding. As of the dates indicated below, the Fund’s debt outstanding and asset coverage was as follows:

 

Date    Total Amount
Outstanding
     % of Asset
Coverage of
Indebtedness
 

12/31/2014

   $ 385,336,455         323.0

12/31/2013

     318,500,000         327.5   

12/31/2012

     225,000,000         311.7   

12/31/2011

     173,000,000         356.1   

12/31/2010

     120,000,000         510.6   

12/31/2009

     112,000,000         509.6   

12/31/2008

     141,000,000         356.2   

12/31/2007

     248,000,000         350.4   

Note 8. Investment Advisory, Administration and Trustee Fees Investment Advisory Fee

The Investment Adviser to the Fund receives an annual fee, paid monthly, in an amount equal to 1.00% of the average weekly value of the Fund’s Managed Assets. The Fund’s “Managed Assets” is an amount equal to the total assets of the Fund, including any form of investment leverage, minus all accrued expenses incurred in the normal course of operations, but not excluding any liabilities or obligations attributable to investment leverage obtained through (i) indebtedness of any type (including, without limitation, borrowing through a credit facility or the issuance of debt securities), (ii) the issuance of preferred stock or other similar preference securities, (iii) the reinvestment of collateral received for securities loaned in accordance with the Fund’s investment objectives and policies, and/or (iv) any other means.

Administration Fee

The Investment Adviser provides administrative services to the Fund. For its services, the Investment Adviser receives an annual fee, payable monthly, in an amount equal to 0.20% of the average weekly value of the Fund’s Managed Assets. Under a separate sub-administration agreement, the Investment Adviser has delegated certain administrative functions to State Street Bank and Trust Company. The Investment Adviser pays State Street Bank and Trust Company directly for these sub-administration services.

Fees Paid to Officers and Trustees

Each Trustee who is not an “interested person” of the Fund as defined in the 1940 Act (the “Independent Trustees”) receives an annual retainer of $150,000 payable in quarterly installments and allocated among each portfolio in the Highland Fund Complex based on relative net assets. The “Highland Fund Complex” consists of all of the registered investment companies and NexPoint Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act, which are each advised by the Investment Adviser or its affiliated advisors as of the date of this report. The Fund pays no compensation to its two interested Trustees or any of its officers, all of whom are employees of the Investment Adviser.

Note 9. Disclosure of Significant Risks and Contingencies

The primary risks of investing in the Fund are described below in alphabetical order:

Concentration Risk

The Fund may focus its investments in instruments of only a few companies. The concentration of the Fund’s portfolio in any one obligor would subject the Fund to a greater degree of risk with respect to defaults by such obligor, and the concentration of the portfolio in any one industry would subject the Fund to a greater degree of risk with respect to economic downturns relating to such industry.

Counterparty Credit Risk

Counterparty credit risk is the potential loss the Fund may incur as a result of the failure of a counterparty or an issuer to make payments according to the terms of a contract. Counterparty credit risk is measured as the loss the Fund would record if its counterparties failed to perform pursuant to the terms of their obligations to the Fund. Because the Fund may enter into over-the-counter forwards, options, swaps and other derivative financial instruments, the Fund may be exposed to the credit risk of its counterparties. To limit the counterparty credit risk associated with such transactions, the Fund conducts

 

 

Annual Report       27


Table of Contents

NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

business only with financial institutions judged by the Investment Adviser to present acceptable credit risk.

Credit Risk

Investments rated below investment grade are commonly referred to as high-yield, high risk or “junk debt.” They are regarded as predominantly speculative with respect to the issuing company’s continuing ability to meet principal and/ or interest payments. Investments in high yield debt and high yield Senior Loans may result in greater net asset value fluctuation than if the Fund did not make such investments.

Corporate debt obligations, including Senior Loans, are subject to the risk of non-payment of scheduled interest and/or principal. Non-payment would result in a reduction of income to the Fund, a reduction in the value of the corporate debt obligation experiencing non-payment and a potential decrease in the NAV of the Fund.

Currency Risk

A portion of the Fund’s assets may be quoted or denominated in non-U.S. currencies. These securities may be adversely affected by fluctuations in relative currency exchange rates and by exchange control regulations. The Fund’s investment performance may be negatively affected by a devaluation of a currency in which the Fund’s investments are quoted or denominated. Further, the Fund’s investment performance may be significantly affected, either positively or negatively, by currency exchange rates because the U.S. dollar value of securities quoted or denominated in another currency will increase or decrease in response to changes in the value of such currency in relation to the U.S. dollar.

Emerging Markets Risk

Any investments in Emerging Market Countries (countries in which the capital markets are developing) may involve greater risks than investments in more developed markets and the prices of such investments may be more volatile. The consequences of political, social or economic changes in these markets may have disruptive effects on the market prices of the Fund’s investments and the income they generate, as well as the Fund’s ability to repatriate such amounts.

Foreign Securities Risk

Investments in foreign securities involve certain factors not typically associated with investing in U.S. securities, such as risks relating to (i) currency exchange matters, including fluctuations in the rate of exchange between the U.S. dollar (the currency in which the books of the Fund are maintained) and the various foreign currencies in which the

Fund’s portfolio securities will be denominated and costs associated with conversion of investment principal and income from one currency into another; (ii) differences between the U.S. and foreign securities markets, including the absence of uniform accounting, auditing and financial reporting standards and practices and disclosure requirements, and less government supervision and regulation; (iii) political, social or economic instability; and (iv) the extension of credit, especially in the case of sovereign debt.

Forward Foreign Currency Exchange Contracts Risk

The Fund is subject to foreign currency exchange rate risk in the normal course of pursuing its investment objectives. The Fund may use forward contracts to gain exposure to, or hedge against changes in the value of foreign currencies. Upon entering into such contracts, the Fund bears the risk of exchange rates moving unexpectedly, in which case, the Fund may not achieve the anticipated benefits of the forward contracts and may realize a loss. With forwards, there is counterparty credit risk to the Fund because the forwards are not exchange-traded, and there is no clearinghouse to guarantee the forwards against default.

Hedging Transactions Risk

The Fund may engage in “hedging,” the practice of attempting to offset a potential loss in one position by establishing an opposite position in another investment. Hedging strategies in general are usually intended to limit or reduce investment risk, but can also be expected to limit or reduce the potential for profit. For example, if the Fund has taken a defensive posture by hedging its portfolio, and stock prices advance, the return to investors will be lower than if the portfolio had not been hedged. No assurance can be given that any particular hedging strategy will be successful or that the Investment Adviser will elect to use a hedging strategy at a time when it is advisable.

Illiquid Securities Risk

The investments made by the Fund may be illiquid, and consequently the Fund may not be able to sell such investments at prices that reflect the Investment Adviser’s assessment of their value or the amount originally paid for such investments by the Fund. Illiquidity may result from the absence of an established market for the investments as well as legal, contractual or other restrictions on their resale and other factors. Furthermore, the nature of the Fund’s investments, especially those in financially distressed companies, may require a long holding period prior to profitability.

 

 

28       Annual Report


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NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

Indemnification Risk

The Fund has a variety of indemnification obligations under contracts with its service providers. The Fund’s maximum exposure under these arrangements is unknown. However, the Fund has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote.

Investments in Foreign Markets Risk

Investments in foreign markets involve special risks and considerations not typically associated with investing in the United States. These risks include revaluation of currencies, high rates of inflation, restrictions on repatriation of income and capital, and adverse political and economic developments. Moreover, securities issued in these markets may be less liquid, subject to government ownership controls, tariffs and taxes, subject to delays in settlements, and their prices may be more volatile.

The Fund may be subject to capital gains and repatriation taxes imposed by certain countries in which they invest. Such taxes are generally based on income and/or capital gains earned or repatriated. Taxes are accrued based upon net investment income, net realized gains and net unrealized appreciation as income and/or capital gains are earned.

Leverage Risk

The Fund may use leverage in its investment program, including the use of borrowed funds and investments in certain types of options, such as puts, calls and warrants, which may be purchased for a fraction of the price of the underlying securities. While such strategies and techniques increase the opportunity to achieve higher returns on the amounts invested, they also increase the risk of loss. To the extent the Fund purchases securities with borrowed funds, its net assets will tend to increase or decrease at a greater rate than if borrowed funds are not used. If the interest expense on borrowings were to exceed the net return on the portfolio securities purchased with borrowed funds, the Fund’s use of leverage would result in a lower rate of return than if the Fund were not leveraged.

Options Risk

There are several risks associated with transactions in options on securities. For example, there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. A transaction in options or securities may be unsuccessful to some degree because of market behavior or unexpected events.

When the Fund writes a covered call option, the Fund forgoes, during the option’s life, the opportunity to profit from increases in the market value of the security covering the call option above the sum of the premium and the strike price of the call, but retains the risk of loss should the price of the underlying security decline. The writer of an option has no control over the time when it may be required to fulfill its obligation and once an option writer has received an exercise notice, it must deliver the underlying security in exchange for the strike price.

When the Fund writes a covered put option, the Fund bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium. If the option is exercised, the Fund could incur a loss if it is required to purchase the stock underlying the put option at a price greater than the market price of the stock at the time of exercise plus the put premium the Fund received when it wrote the option. While the Fund’s potential gain in writing a covered put option is limited to distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, the Fund risks a loss equal to the entire exercise price of the option minus the put premium.

Real Estate Investment Trusts Risk

Real estate investments are subject to various risk factors. Generally, real estate investments could be adversely affected by a recession or general economic downturn where the properties are located. Real estate investment performance is also subject to the success that a particular property manager has in managing the property.

Restricted Securities Risk

Restricted securities (i.e., securities acquired in private placement transactions) and illiquid securities may offer higher yields than comparable publicly traded securities. The Fund, however, may not be able to sell these securities when the Investment Adviser considers it desirable to do so or, to the extent they are sold privately, may have to sell them at less than the price of otherwise comparable securities. Restricted securities are subject to limitations on resale which can have an adverse effect on the price obtainable for such securities. Also, if in order to permit resale the securities are registered under the Securities Act at the Fund’s expense, the Fund’s expenses would be increased.

Senior Loans Risk

The risk that the issuer or a senior loan may fail to pay interest or principal when due, and changes in market interest rates may reduce the value of the senior loan or reduce the Fund’s returns. The risks associated with senior

 

 

Annual Report       29


Table of Contents

NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

loans are similar to the risks of high yield debt securities. Senior loans and other debt securities are also subject to the risk of price declines and to increases in prevailing interest rates. The Fund’s investments in senior loans are typically below investment grade and are considered speculative because of the credit risk of their issuers.

Short-Selling Risk

Short sales by the Fund that are not made where there is an offsetting long position in the asset that it is being sold short theoretically involve unlimited loss potential since the market price of securities sold short may continuously increase. Short selling allows the Fund to profit from declines in market prices to the extent such decline exceeds the transaction costs and costs of borrowing the securities. However, since the borrowed securities must be replaced by purchases at market prices in order to close out the short position, any appreciation in the price of the borrowed securities would result in a loss. Purchasing securities to close out the short position can itself cause the price of securities to rise further, thereby exacerbating the loss. The Fund may mitigate such losses by replacing the securities sold short before the market price has increased significantly. Under adverse market conditions,

the Fund might have difficulty purchasing securities to meet margin calls on its short sale delivery obligations, and might have to sell portfolio securities to raise the capital necessary to meet its short sale obligations at a time when fundamental investment considerations would not favor such sales.

Troubled, Distressed or Bankrupt Companies Risk

The Fund invests in companies that are troubled, in distress or bankrupt. As such, they are subject to a multitude of legal, industry, market, environmental and governmental forces that make analysis of these companies inherently difficult. Further, the Investment Adviser relies on company management, outside experts, market participants and personal experience to analyze potential investments for the Fund. There can be no assurance that any of these sources will prove credible, or that the resulting analysis will produce accurate conclusions.

Note 10. Investment Transactions

For the year ended December 31, 2014, the cost of purchases and proceeds from sales of securities, excluding short-term obligations, were $731,236,263 and $811,599,963, respectively.

 

 

Note 11. Affiliated Issuers

Under Section 2 (a) (3) of the Investment Company Act of 1940, as amended, a portfolio company is defined as “affiliated” if a fund owns five percent or more of its outstanding voting securities. The Fund held at least five percent of the outstanding voting securities of the following companies during the year ended December 31, 2014:

 

                Market Value                    
Issuer   Shares at
December 31,
2013
    Shares at
December 31,
2014
    December 31,
2013
    December 31,
2014
    Affiliated
Income
    Purchases     Sales  

Communications Corp of America (Common Stocks & Exchange-Traded Funds)(1)

    2,010,616        2,317,006      $ 16,084,928      $ 2,826,747      $      $      $   

Endurance Business Media, Inc. Class A (Common Stocks & Exchange-Traded Funds)

    6,480        6,480                                      

Freedom REIT (Common Stocks & Exchange-Traded Funds)(2)

    2,845,299        15,006,336        42,964,014        278,967,787        426,000        193,410,283          

LLV Holdco, LLC (Common Stocks & Exchange-Traded Funds)

    26,869        26,870                                      

Media General, Inc. (Common Stocks & Exchange-Traded Funds)(1)

    4,938,971        4,938,971        111,620,744        82,628,985                        

NexPoint Real Estate Capital, REIT (Common Stocks & Exchange-Traded Funds)

           1,457,100               15,051,843               14,571,000          

NexPoint Residential Trust, Inc., REIT (Common Stocks & Exchange-Traded Funds)

           200,000               2,000               2,000          

Specialty Finance, Inc. (Common Stocks & Exchange-Traded Funds)

           4,762,223      $      $ 4,630,310      $      $ 17,512,223      $ 12,749,975   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    9,828,235        28,714,986      $ 170,669,686      $ 384,107,672      $ 426,000      $ 225,495,506      $ 12,749,975   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

No longer an affiliate as of December 31, 2014.

(2) 

Managed by the same Investment Adviser as the Fund.

 

30       Annual Report


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NOTES TO FINANCIAL STATEMENTS (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

 

Note 12. New Accounting Pronouncements

ASU 2014-11

In June 2014, the Financial Accounting Standards Board issued Accounting Standards Update 2014-11 Transfers and Servicing (Topic 860) — Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures (“ASU 2014-11”). Effective for interim and annual reporting periods in fiscal years that begin after December 15, 2014, ASU 2014-11 requires repurchase-to-maturity transactions to be accounted as secured borrowings, as if the transferor retains effective control of the transferred assets (even though they are not returned to the transferor at settlement). ASU 2014-11 applies to all entities that enter into repurchase-to-maturity transactions or repurchase financings. Although still evaluating the potential impact of ASU 2014-11, Trust management expects that this will not have a material impact on the Fund’s financial statements.

Note 13. Subsequent Events

Management has evaluated the impact of all subsequent events on the Fund through the date the financial statements were issued, and has determined that there were the following subsequent events:

On September 9, 2014, the Board announced a plan to separate NexPoint Residential Trust, Inc. (“NXRT”) from the Fund through a series of restructuring transactions involving Freedom REIT and NXRT followed by a distribution of all of the outstanding shares of NXRT common stock to the shareholders of the Fund on a pro rata basis (the “Spin-Off”). The Board approved the advisory agreement for NXRT on January 5, 2015, and it is expected that the Spin-Off will be completed in early 2015, subject to approval of the advisory agreement for NXRT by shareholders of the Fund.

On February 26, 2015, the Committed Facility Agreement was amended (the “Fifth Amendment”), increasing from $200,000,000 to $225,000,000.

 

 

Annual Report       31


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

     To the Board of Trustees and Shareholders of NexPoint Credit Strategies Fund:

In our opinion, the accompanying statement of assets and liabilities, including the investment portfolio, and the related statements of operations, of cash flows and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of NexPoint Credit Strategies Fund (the “Fund”) at December 31, 2014, the results of its operations and its cash flows 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 five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Fund’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements 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 are free of material misstatement. An audit 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, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at December 31, 2014 by correspondence with the custodian and brokers, provide a reasonable basis for our opinion.

 

LOGO

Dallas, Texas

March 2, 2015

 

32       Annual Report


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ADDITIONAL INFORMATION (unaudited)

 

December 31, 2014   NexPoint Credit Strategies Fund

Additional Portfolio Information

The Investment Adviser and its affiliates manage other accounts, including registered and private funds and individual accounts. Although investment decisions for the Fund are made independently from those of such other accounts, the Investment Adviser may, consistent with applicable law, make investment recommendations to other clients or accounts that may be the same or different from those made to the Fund, including investments in different levels of the capital structure of a company, such as equity versus senior loans, or that involve taking contradictory positions in multiple levels of the capital structure. The Investment Adviser has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal trading by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, this may create situations where a client could be disadvantaged because of the investment activities conducted by the Investment Adviser for other client accounts. When the Fund and one or more of such other accounts is prepared to invest in, or desires to dispose of, the same security, available investments or opportunities for each will be allocated in a manner believed by the Investment Adviser to be equitable to the fund and such other accounts. The Investment Adviser also may aggregate orders to purchase and sell securities for the Fund and such other accounts. Although the Investment Adviser believes that, over time, the potential benefits of participating in volume transactions and negotiating lower transaction costs should benefit all accounts including the Fund, in some cases these activities may adversely affect the price paid or received by the Fund or the size of the position obtained or disposed of by the Fund.

Tax Information

For shareholders that do not have a December 31, 2014 tax year end, this notice is for informational purposes only. For shareholders with a December 31, 2014 tax year end, please consult your tax adviser as to the pertinence of this notice. For the fiscal year ended December 31, 2014, the Fund hereby designates the following items with regard to distributions paid during the year.

 

Qualified
Dividends
and
Corporate
Dividends
Received
Deduction
    Qualified
Dividend
Income
(15% tax
rate for
QDI)
    Qualifying
Interest
Income
 
  6.39     9.05     45.04

Dividend Reinvestment Plan

Unless the registered owner of Common Shares elects to receive cash by contacting American Stock Transfer & Trust Company, LLC (“AST” or the “Plan Agent”), as agent for shareholders in administering the Fund’s dividend reinvestment plan (the “Plan”), all dividends declared for Common Shares of the Fund will be automatically reinvested by AST in additional Common Shares of the Fund. If a registered owner of Common Shares elects not to participate in the Plan, they will receive all dividends in cash paid by check mailed directly to them (or, if the shares are held in street or other nominee name, then to such nominee) by AST, as dividend disbursing agent. Shareholders may elect not to participate in the Plan and to receive all dividends in cash by sending written instructions or by contacting AST, as dividend disbursing agent, at the address set forth below. Participation in the Plan is completely voluntary and may be terminated or resumed at any time without penalty by contacting the Plan Agent before the dividend record date; otherwise such termination or resumption will be effective with respect to any subsequently declared dividend. Some brokers may automatically elect to receive cash on the shareholders’ behalf and may reinvest that cash in additional Common Shares of the Fund for them. The Plan Agent will open an account for each shareholder under the Plan in the same name in which such shareholder’s Common Shares are registered. Whenever the Fund declares a dividend payable in cash, non-participants in the Plan will receive cash and participants in the Plan will receive the equivalent in Common Shares. The Common Shares will be acquired by the Plan Agent for the participants’ accounts, depending upon the circumstances described below, either (i) through receipt of additional unissued but authorized Common Shares from the Fund (“newly issued Common Shares”) or (ii) by purchase of outstanding Common Shares on the open market (“open-market purchases”) on the New York Stock Exchange or elsewhere. If, on the payment date for any dividend, the market price per Common Share plus estimated brokerage commissions is greater than the net asset value per Common Share (such condition being referred to herein as “market premium”), the Plan Agent will invest the dividend amount in newly issued Common Shares, including fractional shares, on behalf of the participants. The number of newly issued Common Shares to be credited to each participant’s account will be determined by dividing the dollar amount of the uninvested portion of the dividend by the net asset value per Common Share on the payment date; provided that, if the net asset value per Common Share is less than 95% of the market price per Common Share on the payment date, the dollar amount of the uninvested portion of the dividend will be divided by

 

 

Annual Report       33


Table of Contents

ADDITIONAL INFORMATION (unaudited) (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

95% of the market price per Common Share on the payment date. If, on the payment date for any dividend, the net asset value per Common Share is greater than the market value per common share plus estimated brokerage commissions (such condition being referred to herein as “market discount”), the Plan Agent will invest the dividend amount in Common Shares acquired on behalf of the participants in open-market purchases. In the event of a market discount on the payment date for any dividend, the Plan Agent will have until the last business day before the next date on which the Common Shares trade on an “ex-dividend” basis or 120 days after the payment date for such dividend, whichever is sooner (the “last purchase date”), to invest the dividend amount in Common Shares acquired in open-market purchases. It is contemplated that the Fund will pay monthly dividends. Therefore, the period during which open-market purchases can be made will exist only from the payment date of each dividend through the date before the “ex-dividend” date of the third month of the quarter. If, before the Plan Agent has completed its open-market purchases, the market price of a Common Share exceeds the net asset value per Common Share, the average per Common Share purchase price paid by the Plan Agent may exceed the net asset value of the Common Shares, resulting in the acquisition of fewer common shares than if the dividend had been paid in newly issued Common Shares on the dividend payment date. Because of the foregoing difficulty with respect to open market purchases, if the Plan Agent is unable to invest the full dividend amount in open market purchases during the purchase period or if the market discount shifts to a market premium during the purchase period, the Plan Agent may cease making open-market purchases and may invest the uninvested portion of the dividend amount in newly issued Common Shares at the net asset value per Common Share at the close of business on the last purchase date; provided that, if the net asset value per Common Share is less than 95% of the market price per Common Share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per Common Share on the payment date. The Plan Agent maintains all shareholders’ accounts in the Plan and furnishes written confirmation of all transactions in the accounts, including information needed by shareholders for tax records. Common Shares in the account of each Plan participant will be held by the Plan Agent on behalf of the Plan participant, and each shareholder proxy will include those shares purchased or received pursuant to the Plan. The Plan Agent will forward all proxy solicitation materials to participants and vote proxies for shares held under the Plan in accordance with the instructions of the participants. In the case of shareholders such as banks, brokers or nominees which hold shares for others who are

the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of Common Shares certified from time to time by the record shareholder’s name and held for the account of beneficial owners who participate in the Plan. There will be no brokerage charges with respect to Common Shares issued directly by the Fund. However, each participant will pay a pro rata share of brokerage commissions incurred in connection with open-market purchases. The automatic reinvestment of dividends will not relieve participants of any federal, state or local income tax that may be payable (or required to be withheld) on such dividends. Accordingly, any taxable dividend received by a participant that is reinvested in additional Common Shares will be subject to federal (and possibly state and local) income tax even though such participant will not receive a corresponding amount of cash with which to pay such taxes. Participants who request a sale of shares through the Plan Agent are subject to a $2.50 sales fee and pay a brokerage commission of $0.05 per share sold. The Fund reserves the right to amend or terminate the Plan. There is no direct service charge to participants in the Plan; however, the Fund reserves the right to amend the Plan to include a service charge payable by the participants. All correspondence concerning the Plan should be directed to the Plan Agent at American Stock Transfer & Trust Company, LLC 6201 15th Avenue Brooklyn, NY 11219; telephone (718) 921-8200.

Shareholder Loyalty Program

To promote loyalty and long-term alignment of interests among the Fund’s shareholders, the Adviser offers an incentive to shareholders that buy and hold the Fund’s common shares for a period of at least twelve months through its Shareholder Loyalty Program (the “Program”). To participate in the Program, existing shareholders must open an account (the “Account”) with the Program’s administrator, American Stock Transfer & Trust Company (“AST”). Subsequently, if a participant makes contributions to the Account during a defined trading period to purchase shares, the Adviser will make a corresponding contribution to create an effective 2% gross up of the participant’s contributions. More specifically, the Adviser’s contribution will account for 2% of the total sum contributed by both the participant and the Adviser. For example, if a participant contributes $9,800 to the Account during a defined trading period to purchase shares, the Adviser will make a corresponding contribution of $200, or 2% of the total $10,000, to purchase additional shares for the participant (the “Bonus Shares”). In addition, Program participants will not be required to pay any customary selling commissions or distribution fees on the purchase of shares under the Program. The Adviser will bear the costs of brokerage fees in connection with the Program. While the portion

 

 

34       Annual Report


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ADDITIONAL INFORMATION (unaudited) (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

of the Fund’s common shares that are acquired through the participant’s contribution will vest immediately, Bonus Shares will not vest until the first anniversary of the date that the Bonus Shares were purchased. Vested shares will be held in the Account and Bonus Shares will be held in an account at AST for the conditional benefit of the shareholder. Under the Program, participants must purchase a minimum of $10,000 worth of shares in the initial subscription and $5,000 in each subsequent subscription, unless the Adviser, in its sole discretion, decides to permit subscriptions for a lesser amount. If the Fund’s common shares are trading at a discount, AST will purchase common shares on behalf of participants in open-market purchases. If the Fund’s common shares are trading at a premium, AST may purchase common shares on behalf of participants in open market purchases or the Fund may sell common shares to the Shareholder Loyalty Program by means of a prospectus or otherwise. All dividends received on shares that are purchased under the Program will be automatically reinvested through the Program. A participant’s interest in a dividend paid to the holder of a vested share will vest immediately. A participant’s interest in a dividend paid to the holder of a Bonus Share will vest at the same time that the Bonus Share’s vesting requirements are met. In addition, for dividends paid to holders of shares that were purchased with a participant’s contributions, the Adviser will make a corresponding contribution to the amount of the reinvested dividend to create an effective 2% gross up of the dividend amount. AST maintains all shareholders’ accounts in the Program and furnishes written confirmation of all transactions in the accounts, including information needed by shareholders for tax records. Shares in the account of each Program participant will be held by AST on behalf of the Program participant, and each shareholder proxy will include those shares purchased or received pursuant to a Program. AST will forward all proxy solicitation materials to participants and vote proxies for shares held under the Program in accordance with the instructions of the participants. In the case of shareholders such as banks, brokers or nominees which hold shares for others who are the beneficial owners, AST will administer the Program on the basis of the number of common shares certified from time to time by the record shareholder’s name and held for the account of beneficial owners who participate in the Program. The Fund and the Adviser reserve the right to amend or terminate the Program. To help align the interests of the Adviser’s employees with the interests of the Fund’s shareholders, the Adviser offers a similar program to its employees. Participants in the Program should be aware that their receipt of Bonus Shares under the Program constitutes taxable income to them. In addition, such participants owe taxes on that portion of any distribution that

constitutes taxable income in respect of shares of our common stock held in their Program accounts, whether or not such shares of common stock have vested in the hands of the participants. To the extent any payments or distributions under the Program are subject to U.S. federal, state or local taxes, the Fund, any participating affiliate of the Fund or the agent for the Program may satisfy its tax withholding obligation by (1) withholding shares of Stock allocated to the participant’s account, (2) deducting cash from the participant’s account or (3) deducting cash from any other compensation the participant may receive. Program participants should consult their tax advisers regarding the tax consequences to them of participating in the Program.

The Program may create an incentive for shareholders to invest additional amounts in the Trust. Because the Adviser’s management fee is based on a percentage of the assets of the Trust, the Program will result in increased net revenues to the Adviser if the increase in the management fee due to the increased asset base offsets the costs associated with establishing and maintaining the Program.

Approval of Investment Advisory Agreement for NexPoint Credit Strategies Fund

The Fund has retained the Investment Advisor to manage the assets of the Fund pursuant to an investment advisory agreement between the Investment Advisor and the Fund (the “Advisory Agreement”). The Advisory Agreement has been approved by the Fund’s Board of Trustees, including a majority of the Independent Trustees.

Following an initial two-year term, the Advisory Agreement continues in effect from year-to-year, provided such continuance is specifically approved at least annually by the vote of holders of at least a majority of the outstanding shares of the Fund or by the Board of Trustees and, in either event, by a majority of the Independent Trustees of the Fund casting votes in person at a meeting called for such purpose.

The Board of Trustees held a meeting of the board on August 28, 2014, at which meeting they gave preliminary consideration to information bearing on the continuation of the Advisory Agreement for a one-year period commencing December 31, 2014. The primary purpose of the meeting was to ensure that the Trustees had ample opportunity to consider matters they deemed relevant in considering the continuation of the Advisory Agreement, and to request any additional information they considered reasonably necessary to their deliberations, without undue time constraints.

At a meeting held on September 11-12, 2014, the Board of Trustees, including the Independent Trustees, approved the

 

 

Annual Report       35


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ADDITIONAL INFORMATION (unaudited) (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

continuance of the Advisory Agreement for a one-year period commencing December 31, 2014. As part of its review process, the Board of Trustees requested, through Fund counsel and its independent legal counsel, and received from the Investment Advisor, various information and written materials in connection with meetings of the Board of Trustees held on August 28, 2014 and September 11-12, 2014, including: (1) information regarding the financial soundness of the Investment Advisor and the profitability of the Advisory Agreement to the Investment Advisor; (2) information on the advisory and compliance personnel of the Investment Advisor, including compensation arrangements; (3) information on the internal compliance procedures of the Investment Advisor; (4) comparative information showing how the Fund’s fees and operating expenses compared to those of other registered investment companies and comparable funds that follow investment strategies similar to that of the Fund; (5) information on the investment performance of the Fund, including comparisons of the Fund’s performance against that of other registered investment companies and comparable funds that follow investment strategies similar to that of the Fund; (6) information regarding brokerage and portfolio transactions; and (7) information on any legal proceedings or regulatory audits or investigations affecting the Investment Advisor. The Trustees also relied on information provided at periodic meetings of the Trustees over the course of the year. In addition, the Trustees received an independent report from Keil Fiduciary Strategies (“KFS”), an independent source of investment company data, relating to the Fund’s performance, volatility and expenses compared to the performance, volatility and expenses of a peer group determined by KFS to be comparable. The Trustees reviewed various factors discussed in independent counsel’s legal memorandum, the detailed information provided by the Investment Advisor and other relevant information and factors. The Trustees’ conclusions as to the approval of the Advisory Agreement were based on a comprehensive consideration of all information provided to the Trustees without any single factor being dispositive in and of itself. Some of the factors that figured particularly in the Trustees’ deliberations are described below, although individual Trustees may have evaluated the information presented differently from one another, giving different weights to various factors.

The nature, extent, and quality of the services to be provided by the Investment Advisor — The Board of Trustees considered the portfolio management services to be provided by the Investment Advisor under the Advisory Agreement and the activities related to portfolio management, including use of technology, research capabilities, and investment management staff. The Board of Trustees discussed the relevant experience and qualifications of the

personnel providing advisory services, including the background and experience of the members of the Fund’s portfolio management team. The Trustees reviewed the management structure, assets under management and investment philosophies and processes of the Investment Advisor. The Trustees also reviewed and discussed information regarding the Investment Advisor’s compliance policies, procedures and personnel, including compensation arrangements. The Trustees concluded that the Investment Advisor had the quality and depth of personnel and investment methods essential to performing its duties under the Advisory Agreement, and that the nature and the quality of such advisory services were satisfactory.

The Investment Advisor’s Historical Performance in Managing the Fund — The Board of Trustees reviewed the historical performance of the Investment Advisor and the Fund’s portfolio management team in managing the Fund over various time periods and reflected on previous discussions regarding matters bearing on the Investment Advisor’s performance at their meetings throughout the year. With respect to the Fund, the Trustees discussed relative performance and contrasted the performance of the Fund and its portfolio management team versus that of the Fund’s peers, as represented by certain other registered investment companies that follow investment strategies similar to the Fund as well as a comparable index and the Fund’s Morningstar category.

The Fund outperformed its comparable index and the Morningstar category for the one-, three- and five-year periods ended June 30, 2014. The Trustees also took into account management’s discussion of the Fund’s performance. Additionally, the Trustees considered the expenses of the Fund in relation to a combination of three Morningstar categories (conservative allocation, multisector bond, and tactical allocation (the Fund’s category)), due to the unique nature of the Fund as compared to potential peers. The Trustees further considered that the Fund’s actual management fees and total expenses (exclusive of 12b-1 fees) were above comparable funds. It was noted that the Fund’s other expenses and interest expenses from leverage contributed to the Fund’s higher total expense ratio. Additionally, the Trustees considered the Fund’s management fee in that context, and determined that the fees were reasonable in relation to the services rendered. The Trustees concluded that the Fund’s performance and other relevant factors supported the renewal of the Advisory Agreement.

The costs of the services to be provided by the Investment Advisor and the profits to be realized by the Investment Advisor and its affiliates from the relationship with the Fund — The Board of Trustees also gave substantial consideration to the fees payable under the

 

 

36       Annual Report


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ADDITIONAL INFORMATION (unaudited) (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

Advisory Agreement, the expenses the Investment Advisor incurs in providing advisory services and the profitability to the Investment Advisor of managing the Fund, including: (1) information regarding the financial condition of the Investment Advisor; (2) information regarding the total fees and payments received by the Investment Advisor for its services, including under a separate agreement for providing administrative services, and whether such fees are appropriate given economies of scale and other considerations; and (3) comparative information showing (a) the fees payable under the Advisory Agreement and the actual fees paid by the Fund to the Investment Advisor versus the investment advisory fees of certain registered investment companies and comparable funds that follow investment strategies similar to that of the Fund and (b) the expense ratios of the Fund versus the expense ratios of certain registered investment companies and comparable funds that follow investment strategies similar to that of the Fund. The Trustees also considered the so-called “fall-out benefits” to the Investment Advisor with respect to the Fund, such as the reputational value of serving as Investment Advisor to the Fund, potential fees paid to the Investment Advisor’s affiliates by the Fund or portfolio companies for services provided, including administrative services provided to the Fund by the Investment Advisor pursuant to a separate agreement, and the benefits of research made available to the Investment Advisor by reason of brokerage commissions (if any) generated by the Fund’s securities transactions. After such review, the Trustees determined that the anticipated profitability rates to the Investment Advisor with respect to the Advisory Agreement were fair and reasonable.

The extent to which economies of scale would be realized as the Fund grows and whether fee levels reflect these economies of scale for the benefit of shareholders — The Board of Trustees considered the asset levels of the Fund, the information provided by the Investment Advisor relating to its costs and information comparing the fee rates charged by the Investment Advisor with fee rates charged by other unaffiliated Investment Advisors to their clients. The Trustees concluded that the fee structure is reasonable, and appropriately should result in a sharing of economies of scale in view of the information provided by the Investment Advisor. The Board determined to continue to review ways, and the extent to which, economies of scale might be shared between the Investment Advisor on the one hand and shareholders of the Fund on the other.

Conclusion — Following a further discussion of the factors above and the merits of the Advisory Agreement and its various provisions, it was noted that in considering the approval of the Advisory Agreement, no single factor was determinative to the decision of the Board of Trustees. Rather, after weighing all of the factors and reasons discussed above, the Trustees, including the Independent Trustees, unanimously agreed that the Advisory Agreement, including the advisory fees to be paid to the Investment Advisor, is fair and reasonable to the Fund in light of the services that the Investment Advisor provides, the expenses that it incurs and the reasonably foreseeable asset levels of the Fund.

 

 

Annual Report       37


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ADDITIONAL INFORMATION (unaudited) (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

Trustees and Officers

The Board of Trustees (“Board”) provides broad oversight of the operations and affairs of the Fund and protects the interests of shareholders. The Board has overall responsibility to manage and control the business affairs of the Fund, including the complete and exclusive authority to establish policies regarding the management, conduct and operation of the Funds’ business. The names and birth dates of the Trustees and officers of the Fund, the year each was first elected or appointed to office, their principal business occupations during the last five years, the number of funds overseen by each Trustee and other directorships or trusteeships they hold are shown below. The business address for each Trustee and officer of the Fund is c/o Highland Capital Management Fund Advisors, L.P., 200 Crescent Court, Suite 700, Dallas, Texas 75201. The Statement of Additional Information includes additional information about the Trustees and is available, without charge, upon request, by calling (877) 665-1287.

 

Name and

Date of Birth

  Position(s)
with the
Funds
  Term of
Office and
Length of
Time Served1
  

Principal Occupation(s)

During the
Past Five Years

 

Number of
Portfolios in
Highland
Fund Complex
Overseen by

the Trustee2

  Other
Directorships/
Trusteeships
Held During
the Past Five
Years
 

Experience, Qualifications,

Attributes, Skills for Board
Membership During the
Past Five Years

Independent Trustees

Timothy K. Hui

(6/13/1948)

  Trustee  

3 year term (expiring at 2017 annual meeting);

Trustee since inception in 2006

   Dean of Educational Resources since July 2012 and from July 2006 to January 2008, Vice President from February 2008 to June 2012, and Assistant Provost for Graduate Education from July 2004 to June 2006 at Cairn University.   15   None   Significant experience
on this and/or other
boards of directors/
trustees;
administrative and
managerial
experience; legal
training and practice.

Bryan A. Ward

(2/4/1955)

  Trustee   3 year term (expiring at 2016 annual meeting); Trustee since inception in 2006    Private Investor; Senior Manager, Accenture, LLP (a consulting firm) from 2002 until retirement in 2014.   15   Director of
Equity Metrix,
LLC
  Significant experience
on this and/or other
boards of directors/
trustees; significant
managerial and
executive experience;
significant experience
as a management
consultant.

Terrence O. Jones

(7/3/1963)

  Trustee   3 year term (expiring at 2015 annual meeting); Trustee since December 2013    Chief Investment Officer, Banco Santander/Optimal Investments from November 2008 to April 2009; Founder and President, Battersby Capital Management LLC from January 2006 to November 2008; and Managing Director, Goldman Sachs Hedge Fund Strategies from December 2001 to December 2005.   15   SEI’s Advisor’s
Inner Circle
Fund III;
Genworth
Life
Insurance
Company of
New York
  Significant experience
in the financial
industry; significant
managerial and
executive experience,
including experience
as founder and
president of an
investment
management bank
and as chief
investment officer of
a private investment
firm; experience on
other boards of
directors.

 

38       Annual Report


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ADDITIONAL INFORMATION (unaudited) (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

Trustees and Officers

Name and

Date of Birth

 

Position(s)

with the

Funds

 

Term of Office

and Length of

Time Served1

  

Principal Occupation(s)

During the

Past Five Years

 

Number of
Portfolios in
Highland
Fund Complex
Overseen by

the Trustee2

  Other
Directorships/
Trusteeships Held
During the Past
Five Years
 

Experience, Qualifications,

Attributes, Skills for Board
Membership During the
Past Five Years

Independent Trustees

Dr. Bob Froehlich

(4/28/1953)

  Trustee   3 year term (expiring at 2017 annual meeting); Trustee since December 2013    Executive Vice President and Chief Investment Strategist, The Hartford Mutual Funds from 2009 until retirement in 2012; Vice Chairman of Deutsche Asset Management from 2002 to 2009.   15   Director of
American
Realty Capital
Finance Trust, Inc.;
Director of KC
Concessions, Inc.;
Trustee of Realty
Capital Income
Funds; Director of
American Realty
Capital Healthcare
Trust II; Director,
American Realty
Capital Daily Net
Asset Value Trust,
Inc.; Director of
American Sports
Enterprise, Inc.;
Director of
Davidson
Investment
Advisors;
Chairman and
owner, Kane
County Cougars
Baseball Club;
Advisory Board of
Directors, Internet
Connectivity
Group, Inc.;
Director of AR
Capital Acquisition
Corp.; Director of
The Midwest
League of
Professional
Baseball Clubs,
Inc.; Director of
Ozzie’s Outreach
Foundation, Inc.
  Significant experience
in the financial
industry; significant
managerial and
executive experience;
significant experience
on other boards of
directors, including as
a member of several
audit committees.

 

Annual Report       39


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ADDITIONAL INFORMATION (unaudited) (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

Trustees and Officers

Name and

Date of Birth

 

Position(s)

with the

Funds

 

Term of Office

and Length of

Time Served1

  

Principal Occupation(s)

During the

Past Five Years

 

Number of
Portfolios in
Highland
Fund Complex
Overseen by

the Trustee2

  Other
Directorships/
Trusteeships Held
During the Past
Five Years
 

Experience, Qualifications,

Attributes, Skills for Board
Membership During the
Past Five Years

Interested Trustees

John Honis3

(6/16/1958)

  Trustee   3 year term (expiring at 2015 annual meeting); Trustee since July 2013.    President of Rand Advisors, LLC since August 2013; Partner of Highland Capital Management, L.P. (“HCM”) until his resignation in November 2014.   15   None   Significant
experience in the
financial industry;
significant
managerial and
executive
experience,
including
experience as
president, chief
executive officer or
chief restructuring
officer of five
telecommunication
firms; experience
on another board
of directors.

Ethan Powell3

(6/20/1975)

  Trustee; Chairman of the Board, Executive Vice President and Secretary (Principal Executive Officer)   3 year term (expiring at 2016 annual meeting); Trustee since December 2013; Chairman of the Board since December 2013; Executive Vice President since June 2012; Secretary since November 2010    Trustee of NexPoint Credit Strategies Fund, Highland Funds II, Highland Funds I and Highland Special Situations Fund from June 2012 until July 2013; Chief Product Strategist of NexPoint Advisors, L.P. and Highland since 2012; Senior Retail Fund Analyst of HCM since 2007 and of Highland since its inception and Secretary of the funds in the Highland Fund Complex since November 2010.   15   None   Significant
experience in the
financial industry;
significant
executive
experience
including current
and past service as
an officer of funds
in the Highland
Fund Complex;
significant
administrative and
managerial
experience.

 

 

40       Annual Report


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ADDITIONAL INFORMATION (unaudited) (continued)

 

December 31, 2014   NexPoint Credit Strategies Fund

Trustees and Officers

Name and

Date of Birth

  Position(s) with
the Funds
 

Term of

Office and

Length of
Time Served

  Principal  Occupation(s) During Past Five Years
Officers

Brian Mitts

(8/26/1970)

  Treasurer (Principal Accounting Officer and Principal Financial Officer)   Indefinite Term; Treasurer since November 2010   Chief Financial Officer and Financial and Operations Principal of Highland Capital Funds Distributor, Inc. since November 2013; Chief Operations Officer of Highland since 2012; Senior Retail Fund Analyst of HCM since 2007 and Highland since its inception; Principal Accounting Officer and Treasurer of the funds in the Highland Fund Complex since November 2010; Financial and Operations Principal of NexBank Securities, Inc. since 2014.

Ethan Powell

(6/20/1975)

  Trustee; Chairman of the Board; Executive Vice President and Secretary (Principal Executive Officer)   Indefinite Term; Trustee since December 2013; Chairman of the Board since December 2013; Executive Vice President since June 2012; Secretary since November 2010   Chief Product Strategist of Highland since 2012; Senior Retail Fund Analyst of HCM since 2007 and Highland since its inception; and Secretary of the funds in the Highland Fund Complex since November 2010.

Dustin Norris

(1/6/1984)

  Assistant Treasurer   Indefinite Term; Assistant Treasurer since November 2012   Director of Product Strategy at Highland since May 2014; Assistant Treasurer of the funds in the Highland Fund Complex since November 2012; Senior Accounting Manager at Highland from August 2012 to May 2014; Fund Accountant at HCM from June 2010 to August 2012; Auditor at Deloitte & Touche LLP from 2009 to June 2010.

 

1 On an annual basis, as a matter of Board policy, the Governance Committee reviews each Trustee’s performance and determines whether to extend each such Trustee’s service for another year. Effective June 2013, the Board adopted a retirement policy wherein the Governance Committee shall not recommend the continued service as a Trustee of a Board member who is older than 80 years of age at the time the Governance Committee reports its findings to the Board.
2 The “Highland Fund Complex” consists of NHF, each series of Highland Funds I, each series of Highland Funds II and NexPoint Capital, Inc., a closed-end management investment company that has elected to be treated as a business development company under the 1940 Act.
3 Mr. Powell is deemed to be an “interested person” of the Funds under the 1940 Act because of his position with Highland. Mr. Honis may be deemed to be an “interested person” of the Funds under the 1940 Act because of his previous position with HCM, an affiliate of Highland, from which he resigned in November 2014.

 

Annual Report       41


Table of Contents

IMPORTANT INFORMATION ABOUT THIS REPORT

 

Investment Adviser

NexPoint Advisors, L.P.

200 Crescent Court, Suite 700

Dallas, TX 75201

Transfer Agent

American Stock Transfer & Trust Company, LLC

6201 15th Avenue

Brooklyn, NY 11219

Custodian

State Street Bank and Trust Company

One Lincoln Street

Boston, MA 02111

Independent Registered Public Accounting Firm

PricewaterhouseCoopers LLP

2001 Ross Avenue, Suite 1800

Dallas, TX 75201

Fund Counsel

Ropes & Gray LLP

Prudential Tower

800 Boylston Street

Boston, MA 02199-3600

Dechert LLP

1900 K Street, NW

Washington, DC 20006-1110

This report has been prepared for shareholders of NexPoint Credit Strategies Fund (the “Fund”). The Fund mails one shareholder report to each shareholder address. If you would like more than one report, please call shareholder services at 1-866-351-4440 to request that additional reports be sent to you.

A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities, and the Fund’s proxy voting record for the most recent 12-month period ended June 30, are available (i) without charge, upon request, by calling 1-866-351-4440 and (ii) on the SEC’s website at http://www.sec.gov.

The Fund files its complete schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Fund’s Forms N-Q are available on the SEC’s website at http://www.sec.gov and also may be reviewed and copied at the SEC’s Public Reference Room in Washington, DC. Information on the Public Reference Room may be obtained by calling 1-800-SEC-0330. Shareholders may also obtain the Form N-Q by visiting the Fund’s website at www.NexPointAdvisors.com.

On June 20, 2014, the Fund submitted a CEO annual certification to the New York Stock Exchange (“NYSE”) on which the Fund’s principal executive officer certified that he was not aware, as of the date, of any violation by the Fund of the NYSE’s Corporate Governance listing standards. In addition, as required by Section 302 of the Sarbanes-Oxley Act of 2002 and related SEC rules, the Fund’s principal executive officer and principal financial officer made quarterly certifications, included in filings with the SEC on Forms N-CSR and N-Q relating to, among other things, the Fund’s disclosure controls and procedures and internal controls over financial reporting, as applicable.

 

 

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LOGO

6201 15th Avenue

Brooklyn, NY 11219

LOGO

NexPoint Credit Strategies Fund    Annual Report, December 31, 2014
www.nexpointadvisors.com    NexPoint-HCF-AR-12/14


Table of Contents

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.

 

(b)

Not applicable.

 

(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 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.

 

(f)

The Registrant’s code of ethics that applies to the Registrant’s principal executive officer, principle financial officer, principal accounting officer or controller, or persons performing similar functions is filed herewith as Exhibit (a)(1)

Item 3. Audit Committee Financial Expert.

As of the end of the period covered by the report, the Registrant’s Board of Trustees (the “Board”) has determined that Bryan A. Ward, a member of the Audit Committee of the Board (the “Audit Committee”), is an audit committee financial expert as defined by the Securities and Exchange Commission (the “SEC”) in Item 3 of Form N-CSR. Mr. Ward is “independent” as defined in Item 3 of Form N-CSR.

Item 4. Principal Accountant Fees and Services.

Audit Fees

 

(a)

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 for those fiscal years are $204,500 for 2013 and $266,000 for 2014.

Audit-Related Fees

 

(b)

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 are $8,500 for 2013 and $8,500 for 2014. The nature of the services related to agreed-upon procedures, performed on the Registrant’s semi-annual financial statements.


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Tax Fees

 

(c)

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 are $9,833 for 2013 and $10,400 for 2014. The nature of the services related to assistance on the Registrant’s tax returns and excise tax calculations.

All Other Fees

 

(d)

The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant, other than the services reported in paragraphs (a) through (c) of this Item are $0 for 2013 and $0 for 2014.

 

(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:

The Audit Committee shall:

(a) have direct responsibility for the appointment, compensation, retention and oversight of the Registrant’s independent auditors and, in connection therewith, to review and evaluate matters potentially affecting the independence and capabilities of the auditors; and

(b) review and pre-approve (including associated fees) all audit and other services to be provided by the independent auditors to the Registrant and all non-audit services to be provided by the independent auditors to the Registrant’s investment adviser or any entity controlling, controlled by or under common control with the investment adviser (an “Adviser Affiliate”) that provides ongoing services to the Registrant, if the engagement relates directly to the operations and financial reporting of the Registrant; and

(c) establish, to the extent permitted by law and deemed appropriate by the Audit Committee, detailed pre-approval policies and procedures for such services; and

(d) consider whether the independent auditors’ provision of any non-audit services to the Registrant, the Registrant’s investment adviser or an Adviser Affiliate not pre-approved by the Audit Committee are compatible with maintaining the independence of the independent auditors.

 

(e)(2)

The percentage of services described in each of paragraphs (b) through (d) of this Item that were approved by the audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are as follows:

(b) 100%

(c) 100%

(d) N/A

 

(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.


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(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 each of the last two fiscal years of the Registrant was $475,000 for 2013 and $455,500 for 2014.

 

(h)

The Registrant’s Audit Committee has considered whether 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.

Item 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, as amended. It is composed of the following trustees, each of who is not an “interested person” as defined in the 1940 Act:

Dr. Bob Froehlich

Timothy K. Hui

Terrence O. Jones

Bryan A. Ward

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.

NEXPOINT ADVISORS, L.P.

PROXY VOTING POLICY

General Principals

This Policy applies to securities held in Client accounts (including registered investment companies and other pooled investment vehicles) as to which the Company has voting authority, directly or indirectly. Indirect voting authority exists where the Company’s voting authority is implied by a general delegation of investment authority without reservation of proxy voting authority.

The Company shall vote proxies in respect of securities owned by or on behalf of a Client in the Client’s best economic interests and without regard to the interests of the Company or any other Client of the Company.


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Voting Procedures

Monitoring

A member of the settlement group (the “settlement designee”) of the Company shall have responsibility for monitoring portfolios managed by the Company for securities subject to a proxy vote. Upon the receipt of a proxy notice related to a security held in a portfolio managed by the Company, the settlement designee shall forward all relevant information to the Portfolio Manager(s) with responsibility for the security. The Portfolio Manager(s) may consult a member of the settlement group as necessary.

Voting

Upon receipt of notice from the settlement designee, the Portfolio Manager(s) of the fund(s) in which the security subject to a proxy vote shall evaluate the subject matter of the proxy and cause the proxy to be voted on behalf of the Client in accordance with the Guidelines set forth below.

Guidelines

In determining how to vote a particular proxy, the Portfolio Manager(s) shall consider, among other things, the interests of each Client account as it relates to the subject matter of the proxy, any potential conflict of interest the Company may have in voting the proxy on behalf of the Client and the procedures set forth in this Policy. This Policy is designed to be implemented in a manner reasonably expected to ensure that voting rights are exercised in the best interests of the Company’s clients. Each proxy is voted on a case-by-case basis taking into consideration any relevant contractual obligations as well as other relevant facts and circumstances. In general, the Company reviews and considers corporate governance issues related to proxy matters and generally supports proposals that foster good corporate governance practices. Portfolio manager(s) may vote proxies as recommended by the security issuers management on routine matters related to the operation of the issuer and on matters not expected to have a significant impact on the issuer and/or its shareholders, because the Company believes that recommendations by the issuer are generally in shareholders’ best interests, and therefore in the best economic interest of the Company’s clients.

Conflicts of Interest

If the Portfolio Manager(s) determine that the Company may have a potential material conflict of interest (as defined in Section 3 of this Policy) in voting a particular proxy, the Portfolio Manager(s) shall contact the Company’s compliance department prior to causing the proxy to be voted.

For a security held by a an investment company, the Company shall disclose the conflict and its reasoning for voting as it did to the Retail Fund’s Board of Trustees at the next regularly scheduled quarterly meeting. In voting proxies for securities held by an investment company, the Company may consider only the interests of the Fund. It is the responsibility of the compliance department to document the basis for the decision and furnish the documentation to the Board of Trustees. The Company may resolve the conflict of interest by following the proxy voting recommendation of a disinterested third party (such as ISS, Glass Lewis, or another institutional proxy research firm).


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Non-Votes

The Company may determine not to vote proxies in respect of securities of any issuer if it determines it would be in its Client’s overall best interests not to vote. Such determination may apply in respect of all Client holdings of the securities or only certain specified Clients, as the Company deems appropriate under the circumstances. As examples, the Portfolio Manager(s) may determine: (a) not to recall securities on loan if, in its judgment, the matters being voted upon are not material events affecting the securities and the negative consequences to Clients of disrupting the securities lending program would outweigh the benefits of voting in the particular instance or (b) not to vote certain foreign securities positions if, in its judgment, the expense and administrative inconvenience outweighs the benefits to Clients of voting the securities.

Recordkeeping

Following the submission of a proxy vote, the applicable Portfolio Manager(s) shall submit a report of the vote to a settlement designee of the Company. Records of proxy votes by the Company shall be maintained in accordance with the Recordkeeping section of this Policy.

Material Conflicts of Interest

Voting the securities of an issuer where the following relationships or circumstances exist are deemed to give rise to a material conflict of interest for purposes of this Policy:

 

  (i) The issuer is a Client of the Company, or of an affiliate, accounting for more than 5% of the Company’s or affiliate’s annual revenues.

 

  (ii) The issuer is an entity that reasonably could be expected to pay the Company or its affiliates more than $1 million through the end of the Company’s next two full fiscal years.

 

  (iii) The issuer is an entity in which a “Covered Person” (as defined in the Company’s Policies and Procedures Designed to Detect and Prevent Insider Trading and to Comply with Rule 17j-1 of the Investment Company Act of 1940, as amended (the “Code of Ethics”)) has a beneficial interest contrary to the position held by the Company on behalf of Clients.

 

  (iv) The issuer is an entity in which an officer or partner of the Company or a relative of any such person is or was an officer, director or employee, or such person or relative otherwise has received more than $150,000 in fees, compensation and other payment from the issuer during the Company’s last three fiscal years; provided, however, that the Compliance Department may deem such a relationship not to be a material conflict of interest if the Company representative serves as an officer or director of the issuer at the direction of the Company for purposes of seeking control over the issuer.

 

  (v) The matter under consideration could reasonably be expected to result in a material financial benefit to the Company or its affiliates through the end of the Company’s next two full fiscal years (for example, a vote to increase an investment advisory fee for a Fund advised by the Company or an affiliate).


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  (vi) Another Client or prospective Client of the Company, directly or indirectly, conditions future engagement of the Company on voting proxies in respect of any Client’s securities on a particular matter in a particular way.

 

  (vii) The Company holds various classes and types of equity and debt securities of the same issuer contemporaneously in different Client portfolios.

 

  (viii) Any other circumstance where the Company’s duty to serve its Clients’ interests, typically referred to as its “duty of loyalty,” could be compromised.

Notwithstanding the foregoing, a conflict of interest described in Section 3.1 shall not be considered material for the purposes of this Policy in respect of a specific vote or circumstance if:

 

  (i) The securities in respect of which the Company has the power to vote account for less than 1% of the issuer’s outstanding voting securities, but only if: (i) such securities do not represent one of the 10 largest holdings of such issuer’s outstanding voting securities and (ii) such securities do not represent more than 2% of the Client’s holdings with the Company.

 

  (ii) The matter to be voted on relates to a restructuring of the terms of existing securities or the issuance of new securities or a similar matter arising out of the holding of securities, other than common equity, in the context of a bankruptcy or threatened bankruptcy of the issuer.

Recordkeeping

The Company shall retain records relating to the voting of proxies, including:

 

  (i) Copies of this Policy and any amendments thereto;

 

  (ii) A copy of each proxy statement that the Company receives regarding Client securities.

 

  (iii) Records of each vote cast by the Company on behalf of Clients.

 

  (iv) A copy of any documents created by the Company that were material to making a decision how to vote or that memorializes the basis for that decision.

 

  (v) A copy of each written request for information on how the Company voted proxies on behalf of the Client, and a copy of any written response by the Company to any (oral or written) request for information on how the Company voted.


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These records shall be maintained and preserved in an easily accessible place for a period of not less than five years from the end of the Company’s fiscal year during which the last entry was made in the records, the first two years in an appropriate office of the Company.

The Company may rely on proxy statements filed on the SEC’s EDGAR system or on proxy statements and records of votes cast by the Company maintained by a third party, such as a proxy voting service (provided the Company had obtained an undertaking from the third party to provide a copy of the proxy statement or record promptly on request).

Records relating to the voting of proxies for securities held by investment company clients will be reported periodically, as requested, to the investment company’s Board of Trustees and, to the SEC on an annual basis pursuant to Form N-PX.

Item 8. Portfolio Managers of Closed-End Management Investment Companies.

 

(a)(1)

Identification of Portfolio Manager(s) or Management Team Members and Description of Role of Portfolio Manager(s) or Management Team Members

The Registrant’s portfolio manager, who is primarily responsible for the day-to-day management of the Registrant’s portfolio, is James Dondero.

James Dondero – Mr. Dondero has over 25 years of experience in the credit markets. In addition to his role at NexPoint Advisors, L.P., Mr. Dondero is the President of Highland Capital Management, L.P. (“HCM”), which he co-founded in 1993. Prior to founding HCM, Mr. Dondero served as Chief Investment Officer of Protective Life’s GIC subsidiary and helped grow the business from concept to over $2 billion between 1989 and 1993. His portfolio management experience includes mortgage-backed securities, investment grade corporates, leveraged bank loans, high-yield bonds, emerging market debt, derivatives, and preferred stocks and common stocks. He received a BS in Commerce (Accounting and Finance) from the University of Virginia. Mr. Dondero is a Certified Public Accountant, a Certified Management Accountant, and a Chartered Financial Analyst.

 

(a)(2)

Other Accounts Managed by Portfolio Manager(s) or Management Team Member and Potential Conflicts of Interest

Other Accounts Managed by Portfolio Manager(s) or Management Team Member

The following table provides information about funds and accounts, other than the Registrant, for which the Registrant’s portfolio manager is primarily responsible for the day-to-day portfolio management as of December 31, 2014.

James Dondero

 

Type of Accounts

Total

# of Accounts

Managed

Total Assets

(millions)

# of Accounts

Managed with

Performance-Based

Advisory Fee

Total Assets with

Performance-Based

Advisory Fee

(millions)

Registered Investment Companies:

4 $1.3 billion None $0

Other Pooled Investment Vehicles:

None $0 None $0

Other Accounts:

None $0 None $0


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Potential Conflicts of Interests

NexPoint Advisors, L.P. (“NexPoint” or the “Adviser”) and/or its general partner, limited partners, officers, affiliates and employees provide investment advice to other parties and manage other accounts and private investment vehicles similar to the Registrant. In connection with such other investment management activities, the Adviser and/or its general partner, limited partners, officers, affiliates and employees may decide to invest the funds of one or more other accounts or recommend the investment of funds by other parties, rather than the Registrant’s monies, in a particular security or strategy. In addition, the Adviser and such other persons will determine the allocation of funds from the Registrant and such other accounts to investment strategies and techniques on whatever basis they consider appropriate or desirable in their sole and absolute discretion.

The Adviser has built a professional working environment, a firm-wide compliance culture and compliance procedures and systems designed to protect against potential incentives that may favor one account over another. The Adviser has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal trading by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, the Adviser furnishes advisory services to numerous clients in addition to the Registrant, and the Adviser may, consistent with applicable law, make investment recommendations to other clients or accounts (including accounts that are hedge funds or have performance or higher fees paid to the Adviser or in which portfolio managers have a personal interest in the receipt of such fees) that may be the same as or different from those made to the Registrant. In addition, the Adviser, its affiliates and any of their partners, directors, officers, stockholders or employees may or may not have an interest in the securities whose purchase and sale the Adviser recommends to the Registrant. Actions with respect to securities of the same kind may be the same as or different from the action that the Adviser, or any of its affiliates, or any of their partners, directors, officers, stockholders or employees or any member of their families may take with respect to the same securities. Moreover, the Adviser may refrain from rendering any advice or services concerning securities of companies of which any of the Adviser’s (or its affiliates’) partners, directors, officers or employees are directors or officers, or companies as to which the Adviser or any of its affiliates or partners, directors, officers and employees of any of them has any substantial economic interest or possesses material non-public information. In addition to its various policies and procedures designed to address these issues, the Adviser includes disclosure regarding these matters to its clients in both its Form ADV and investment advisory agreements.

The Adviser, its affiliates or their partners, directors, officers and employees similarly serve or may serve other entities that operate in the same or related lines of business or of investment funds managed by affiliates of the Adviser. Accordingly, these individuals may have obligations to investors in those entities or funds or to other clients, the fulfillment of which might not be in the best interests of the Registrant. As a result, the Adviser will face conflicts in the allocation of investment opportunities to the Fund and other funds and clients. In order to enable such affiliates to fulfill their fiduciary duties to each of the clients for which they have responsibility, the Adviser will endeavor to allocate investment opportunities in a fair and equitable manner which may, subject to applicable regulatory constraints, involve pro rata co-investment by the Registrant and such other clients or may involve a rotation of opportunities among the Registrant and such other clients.


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While the Adviser does not believe there will be frequent conflicts of interest, if any, the Adviser and its affiliates have both subjective and objective procedures and policies in place designed to manage the potential conflicts of interest between the Adviser’s fiduciary obligations to the Registrant and their similar fiduciary obligations to other clients so that, for example, investment opportunities are allocated in a fair and equitable manner among the Registrant and such other clients. An investment opportunity that is suitable for multiple clients of the Adviser and its affiliates may not be capable of being shared among some or all of such clients due to the limited scale of the opportunity or other factors, including regulatory restrictions imposed by the 1940 Act. There can be no assurance that the Adviser’s or its affiliates’ efforts to allocate any particular investment opportunity fairly among all clients for whom such opportunity is appropriate will result in an allocation of all or part of such opportunity to the Registrant. Not all conflicts of interest can be expected to be resolved in favor of the Registrant.

 

(a)(3)

Compensation Structure of Portfolio Manager(s) or Management Team Members

NexPoint’s financial arrangements with its portfolio managers, its competitive compensation and its career path emphasis at all levels reflect the value senior management places on key resources. Compensation may include a variety of components and may vary from year to year based on a number of factors, including the relative performance of a portfolio manager’s underlying account, the combined performance of the portfolio managers’ underlying accounts, and the relative performance of the portfolio managers’ underlying accounts measured against other employees. The principal components of compensation include a base salary, a discretionary bonus, various retirement benefits and one or more of the incentive compensation programs established by NexPoint, such as its “Short-Term Incentive Plan” and its “Long-Term Incentive Plan,” described below.

Base compensation. Generally, portfolio managers receive base compensation based on their seniority and/or their position with NexPoint, which may include the amount of assets supervised and other management roles within NexPoint. Base compensation is determined by taking into account current industry norms and market data to ensure that NexPoint pays a competitive base compensation.

Discretionary compensation. In addition to base compensation, portfolio managers may receive discretionary compensation, which can be a substantial portion of total compensation. Discretionary compensation can include a discretionary cash bonus paid to recognize specific business contributions and to ensure that the total level of compensation is competitive with the market, as well as participation in incentive plans, including one or more of the following:

Short-Term Incentive Plan. The purpose of this plan is to attract and retain the highest quality employees for positions of substantial responsibility, and to provide additional incentives to a select group of management or highly-compensated employees of NexPoint in order to promote the success of NexPoint.

Long Term Incentive Plan. The purpose of this plan is to create positive morale and teamwork, to attract and retain key talent, and to encourage the achievement of common goals. This plan seeks to reward participating employees based on the increased value of NexPoint through the use of Long-Term Incentive Units.

Because each person’s compensation is based on his or her individual performance, NexPoint does not have a typical percentage split among base salary, bonus and other compensation. Senior portfolio managers who perform additional management functions may receive additional compensation in these other capacities. Compensation is structured such that key professionals benefit from remaining with NexPoint.


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(a)(4)

Disclosure of Securities Ownership

The following table sets forth the dollar range of equity securities beneficially owned by the portfolio manager in the Registrant as of December 31, 2014.

 

Name of Portfolio Manager    

Dollar Ranges of Equity Securities Beneficially Owned by

Portfolio Manager

James Dondero

Over $1,000,000

 

(b)

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.

Item 11. Controls and Procedures.

 

(a)

The Registrant’s principal executive and principal financial officers, or persons performing similar functions, have concluded that the Registrant’s disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended (the “1940 Act”) (17 CFR 270.30a-3 (c)) are effective, as of a date within 90 days of the filing date of the report that includes the disclosure required by this paragraph, based on their evaluation of these controls and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)).

 

(b)

There were no changes in the Registrant’s internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR 270.30a-3(d)) that occurred during the Registrant’s second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting.

Item 12. Exhibits.

 

(a)(1)

Code of ethics, or 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.


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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.

NEXPOINT CREDIT STRATEGIES FUND

 

By (Signature and Title):            

/s/ Ethan Powell

Ethan Powell

Executive Vice President and Principal Executive Officer

(Principal Executive Officer)

Date:    March 6, 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/ Ethan Powell

Ethan Powell

Executive Vice President and Principal Executive Officer

(Principal Executive Officer)

Date:    March 6, 2015

By (Signature and Title):

/s/ Brian Mitts

Brian Mitts

Chief Financial Officer and Treasurer

(Principal Financial Officer)

Date:    March 6, 2015