N-CSR 1 etf7_ncsr.txt ANNUAL REPORT 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 811-22767 ----------- First Trust Exchange-Traded Fund VII ------------------------------------------------------------ (Exact name of registrant as specified in charter) 120 East Liberty Drive, Suite 400 Wheaton, IL 60187 ------------------------------------------------------------ (Address of principal executive offices) (Zip code) W. Scott Jardine, Esq. First Trust Portfolios L.P. 120 East Liberty Drive, Suite 400 Wheaton, IL 60187 ------------------------------------------------------------ (Name and address of agent for service) Registrant's telephone number, including area code: (630) 765-8000 ---------------- Date of fiscal year end: December 31 ------------- Date of reporting period: December 31, 2016 ------------------- Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles. A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. ss. 3507. ITEM 1. REPORT TO STOCKHOLDERS. The registrant's annual report transmitted to shareholders pursuant to Rule 30e-1 under the Investment Company Act of 1940 is as follows: FIRST TRUST First Trust Exchange-Traded Fund VII -------------------------------------------------------------------------------- First Trust Global Tactical Commodity Strategy Fund (FTGC) ---------------------------- Annual Report For the Year Ended December 31, 2016 ---------------------------- -------------------------------------------------------------------------------- TABLE OF CONTENTS -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) ANNUAL REPORT DECEMBER 31, 2016 Shareholder Letter......................................................... 1 Fund Performance Overview.................................................. 2 Portfolio Commentary....................................................... 4 Understanding Your Fund Expenses........................................... 6 Consolidated Portfolio of Investments...................................... 7 Consolidated Statement of Assets and Liabilities........................... 9 Consolidated Statement of Operations....................................... 10 Consolidated Statements of Changes in Net Assets........................... 11 Consolidated Financial Highlights.......................................... 12 Notes to Consolidated Financial Statements................................. 13 Report of Independent Registered Public Accounting Firm.................... 19 Additional Information..................................................... 20 Board of Trustees and Officers............................................. 24 Privacy Policy............................................................. 26 CAUTION REGARDING FORWARD-LOOKING STATEMENTS This report contains certain forward-looking statements within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements regarding the goals, beliefs, plans or current expectations of First Trust Advisors L.P. ("First Trust" or the "Advisor") and its representatives, taking into account the information currently available to them. Forward-looking statements include all statements that do not relate solely to current or historical fact. For example, forward-looking statements include the use of words such as "anticipate," "estimate," "intend," "expect," "believe," "plan," "may," "should," "would" or other words that convey uncertainty of future events or outcomes. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of First Trust Global Tactical Commodity Strategy Fund (the "Fund") to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. When evaluating the information included in this report, you are cautioned not to place undue reliance on these forward-looking statements, which reflect the judgment of the Advisor and its representatives only as of the date hereof. We undertake no obligation to publicly revise or update these forward-looking statements to reflect events and circumstances that arise after the date hereof. PERFORMANCE AND RISK DISCLOSURE There is no assurance that the Fund will achieve its investment objective. The Fund is subject to market risk, which is the possibility that the market values of investments owned by the Fund will decline and that the value of the Fund shares may therefore be less than what you paid for them. Accordingly, you can lose money investing in the Fund. See "Risk Considerations" in the Additional Information section of this report for a discussion of other risks of investing in the Fund. Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. For the most recent month-end performance figures, please visit http://www.ftportfolios.com or speak with your financial advisor. Investment returns, net asset value and share price will fluctuate and Fund shares, when sold, may be worth more or less than their original cost. The Advisor may also periodically provide additional information on Fund performance on the Fund's webpage at http://www.ftportfolios.com. HOW TO READ THIS REPORT This report contains information that may help you evaluate your investment in the Fund. It includes details about the Fund's portfolio and presents data and analysis that provide insight into the Fund's performance and investment approach. By reading the portfolio commentary from the portfolio management team of the Fund, you may obtain an understanding of how the market environment affected the Fund's performance. The statistical information that follows may help you understand the Fund's performance compared to that of relevant market benchmarks. It is important to keep in mind that the opinions expressed by personnel of the Advisor are just that: informed opinions. They should not be considered to be promises or advice. The opinions, like the statistics, cover the period through the date on the cover of this report. The material risks of investing in the Fund are spelled out in its prospectus, statement of additional information, this report and other Fund regulatory filings. -------------------------------------------------------------------------------- SHAREHOLDER LETTER -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) ANNUAL LETTER FROM THE CHAIRMAN AND CEO DECEMBER 31, 2016 Dear Shareholders: Now that 2016 is over, many will remember some of the historic events that occurred during the year: from the Brexit vote in the UK to leave the European Union, to the results of the U.S. Presidential Election which seemed unlikely at the beginning of the year, to the first World Series Championship for the Chicago Cubs in 108 years! First Trust Advisors L.P. ("First Trust") is pleased to provide you with this annual report which contains detailed information about your investment for the 12 months ended December 31, 2016, including a performance analysis and the financial statements for you to review. We encourage you to read this report and discuss it with your financial advisor. On November 8, Donald J. Trump was elected to become the 45th president in our country's history. While no one has a crystal ball and the ability to predict how his presidency will shape the United States (and the world), there is no doubt that his populist message resonated for many Americans. And his message of improving lives for the "average" American, while reducing the size and scope of the federal government, also won him millions of votes. Many of his supporters believe that with his background in business, President Trump will make policy changes that will continue to grow the economy and spur stock markets even higher. Many analysts predicted the Dow Jones Industrial Average would hit a new benchmark, 20,000, in the first days of the New Year. As with all change and a new administration, only time will tell. As of December 31, 2016, the S&P 500(R) Index was up 11.96% calendar year-to-date, on a total return basis, as measured by Bloomberg. The current bull market (measuring from March 9, 2009 through December 31, 2016) is the second longest in history. We remain bullish on the economy, but continue to have a long-term perspective. We believe investors should think long-term as well, since no one can predict volatility and the inevitable ups and downs that occur in the market. Thank you for your investment in First Trust Global Tactical Commodity Strategy Fund and for giving First Trust the opportunity to be a part of your investment plan. We value our relationship with you and will continue our relentless focus on bringing the types of investments that we believe could help you reach your financial goals. Sincerely, /s/ James A. Bowen James A. Bowen Chairman of the Board of Trustees Chief Executive Officer of First Trust Advisors L.P. Page 1 -------------------------------------------------------------------------------- FUND PERFORMANCE OVERVIEW (UNAUDITED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) First Trust Global Tactical Commodity Strategy Fund's (the "Fund") investment objective is to seek to provide total return by providing investors with commodity exposure while seeking a relatively stable risk profile. The Fund is an actively managed exchange-traded fund ("ETF") that seeks to achieve attractive risk-adjusted return by investing in commodity futures contracts and exchange-traded commodity linked instruments (collectively, "Commodities Instruments") through a wholly-owned subsidiary of the Fund organized under the laws of the Cayman Islands (the "Subsidiary"). The Fund expects to gain exposure to these investments exclusively by investing in the Subsidiary. The Subsidiary is advised by First Trust Advisors L.P., the Fund's advisor (the "Advisor"). The Fund's investment in the Subsidiary is intended to provide the Fund with exposure to commodity markets within the limits of current federal income tax laws applicable to investment companies such as the Fund, which limit the ability of investment companies to invest directly in Commodities Instruments. The Subsidiary has the same investment objective as the Fund, but unlike the Fund, it may invest without limitation in Commodities Instruments. Except as otherwise noted, references to the Fund's investments include the Fund's indirect investments through the Subsidiary. The Fund may invest up to 25% of its total assets in the Subsidiary. The Subsidiary seeks to make investments generally in Commodities Instruments while managing volatility. Investment weightings of the underlying Commodities Instruments held by the Subsidiary are rebalanced in an attempt to stabilize risk levels. The dynamic weighting process is designed to result in a disciplined, systematic investment process, which is keyed off of the Advisor's volatility forecasting process. The Subsidiary may have both long and short positions in Commodities Instruments. However, for a given Commodity Instrument the Subsidiary will provide a net long exposure. The remainder of the Fund's assets will primarily be invested in: (1) short-term investment grade fixed income securities that include U.S. government and agency securities, sovereign debt obligations of non-U.S. countries, and repurchase agreements; (2) money market instruments; (3) ETFs and other investment companies registered under the Investment Company Act of 1940, as amended; and (4) cash and other cash equivalents. The Fund uses such instruments as investments and to collateralize the Subsidiary's Commodities Instruments exposure on a day-to-day basis.
-------------------------------------------------------------------------------------------------------------------- PERFORMANCE -------------------------------------------------------------------------------------------------------------------- AVERAGE ANNUAL CUMULATIVE TOTAL RETURNS TOTAL RETURNS 1 Year Ended Inception (10/22/13) Inception (10/22/13) 12/31/16 to 12/31/16 to 12/31/16 FUND PERFORMANCE NAV 0.54% -11.33% -31.88% Market Price 0.74% -11.31% -31.81% INDEX PERFORMANCE Bloomberg Commodity Index 11.77% -11.13% -31.39% S&P GSCI(R) Total Return Index 11.37% -19.62% -50.19% S&P 500(R) Index 11.96% 10.25% 36.53% --------------------------------------------------------------------------------------------------------------------
Total returns for the period since inception are calculated from the inception date of the Fund. "Average annual total returns" represent the average annual change in value of an investment over the period indicated. "Cumulative total returns" represent the total change in value of an investment over the period indicated. The Fund's per share net asset value ("NAV") is the value of one share of the Fund and is computed by dividing the value of all assets of the Fund (including accrued interest and dividends), less all liabilities (including accrued expenses and dividends declared but unpaid), by the total number of outstanding shares. The price used to calculate market return ("Market Price") is determined by using the midpoint between the highest bid and the lowest offer on the stock exchange on which shares of the Fund are listed for trading as of the time that the Fund's NAV is calculated. Since shares of the Fund did not trade in the secondary market until after its inception, for the period from inception to the first day of secondary market trading in shares of the Fund, the NAV of the Fund is used as a proxy for the secondary market trading price to calculate market returns. NAV and market returns assume that all dividend distributions have been reinvested in the Fund at NAV and Market Price, respectively. An index is a statistical composite that tracks a specified financial market or sector. Unlike the Fund, indices do not actually hold a portfolio of securities and therefore do not incur the expenses incurred by the Fund. These expenses negatively impact the performance of the Fund. Also, index returns do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, index returns would be lower. The total returns presented reflect the reinvestment of dividends on securities in the indices. The returns presented do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. The investment return and principal value of shares of the Fund will vary with changes in market conditions. Shares of the Fund may be worth more or less than their original cost when they are redeemed or sold in the market. The Fund's past performance is no guarantee of future performance. Page 2 -------------------------------------------------------------------------------- FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) (CONTINUED)
---------------------------------------------------------------------------------------------------------- Performance of a $10,000 Initial Investment October 22, 2013 - December 31, 2016 First Trust Global Tactical Commodity Bloomberg S&P GSCI(R) Strategy Fund (FTGC) Commodity Index Total Return Index S&P 500(R) Index 10/22/13 $10,000 $10,000 $10,000 $10,000 12/31/13 9,930 9,817 9,952 10,580 6/30/14 11,237 10,512 10,520 11,335 12/31/14 8,749 8,147 6,661 12,089 6/30/15 8,259 8,020 6,647 12,177 12/31/15 6,775 6,138 4,472 12,195 6/30/16 7,195 6,952 4,913 12,664 12/31/16 6,811 6,861 4,981 13,654 ----------------------------------------------------------------------------------------------------------
Performance figures assume reinvestment of all distributions and do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. An index is a statistical composite that tracks a specified financial market or sector. Unlike the Fund, the indices do not actually hold a portfolio of investments and therefore do not incur the expenses incurred by the Fund. These expenses negatively impact the performance of the Fund. The Fund's past performance does not predict future performance. FREQUENCY DISTRIBUTION OF DISCOUNTS AND PREMIUMS BID/ASK MIDPOINT VS. NAV THROUGH DECEMBER 31, 2016 The following Frequency Distribution of Discounts and Premiums charts are provided to show the frequency at which the bid/ask midpoint price for the Fund was at a discount or premium to the daily NAV. The following tables are for comparative purposes only and represent the period October 23, 2013 (commencement of trading) through December 31, 2016. Shareholders may pay more than NAV when they buy Fund shares and receive less than NAV when they sell those shares because shares are bought and sold at current market price. Data presented represents past performance and cannot be used to predict future results. -------------------------------------------------------------------------------- NUMBER OF DAYS BID/ASK MIDPOINT AT/ABOVE NAV -------------------------------------------------------------------------------- FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00% 10/23/13 - 12/31/13 36 0 0 0 1/1/14 - 12/31/14 188 5 1 0 1/1/15 - 12/31/15 122 4 1 0 1/1/16 - 12/31/16 142 1 0 0 -------------------------------------------------------------------------------- NUMBER OF DAYS BID/ASK MIDPOINT BELOW NAV -------------------------------------------------------------------------------- FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00% 10/23/13 - 12/31/13 9 3 0 0 1/1/14 - 12/31/14 57 1 0 0 1/1/15 - 12/31/15 124 1 0 0 1/1/16 - 12/31/16 109 0 0 0 Page 3 -------------------------------------------------------------------------------- PORTFOLIO COMMENTARY -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) ANNUAL REPORT DECEMBER 31, 2016 (UNAUDITED) INVESTMENT ADVISOR First Trust Advisors L.P. ("First Trust"), located in Wheaton, Illinois, is the investment advisor, commodity pool operator and commodity trading advisor to the First Trust Global Tactical Commodity Strategy Fund (the "Fund" or "FTGC"). In this capacity, First Trust is responsible for the selection and ongoing monitoring of the investments in the Fund's portfolio and certain other services necessary for the management of the portfolio. First Trust serves as advisor or sub-advisor for four mutual fund portfolios, 10 exchange-traded trusts consisting of 114 series, 16 closed-end funds and a variable insurance trust consisting of three series, and is also the portfolio supervisor of certain unit investment trusts sponsored by First Trust Portfolios L.P. ("FTP"), also located in Wheaton, Illinois. PORTFOLIO MANAGEMENT TEAM JOHN GAMBLA - CFA, FRM, PRM, SENIOR PORTFOLIO MANAGER ROB A. GUTTSCHOW - CFA, SENIOR PORTFOLIO MANAGER COMMENTARY The Fund is an actively managed exchange-traded fund. The Fund's investment objective is to seek to provide total return by providing investors with commodity exposure while seeking a relatively stable risk profile. For performance measurement, the Fund is benchmarked versus the unmanaged Bloomberg Commodity Index (the "Benchmark"). This commentary discusses the 12-month market and Fund performance ended December 31, 2016. OVERALL MARKET RECAP U.S. economic growth was average during the fiscal 12-month period ended December 31, 2016, with U.S. GDP growth estimated to be 2.0% annualized. The U.S. unemployment rate declined throughout the year, falling from 5.0% to 4.7% during the fiscal period. The total number of non-farm payroll jobs added to the U.S. economy during the fiscal period, as measured by the Bureau of Labor Statistics, was approximately 2.16 million. The overall steady performance of the U.S. economy and the slight improvement in the unemployment rate, combined with a patient, wait and see approach by the Federal Reserve Open Market Committee ("FOMC"), boosted equity markets throughout the year. These factors thereby lifted U.S. equity markets (S&P 500(R) Index, the "Index") to a total return of 11.96% for the fiscal period. Equities were up for the year on improving earnings forecasts. The surprise Brexit vote in late June, where voters in the UK chose to leave the European Union, created a short bout of downward volatility which was quickly erased in July. Equity markets drifted sideways to downward from July to November, as the results of the U.S. election were eagerly awaited. Perhaps as shocking as the Brexit vote, Donald Trump won a clear majority in the Electoral College, sparking a two month rally that added 5.0% to the Index's total return for the year. Throughout the year, bond prices rallied as the FOMC pushed potential rate hikes further into the future. Rates on the 10-year U.S. Treasury reached a fiscal period low in early July at 1.35%. Similar to equities, bond yields then drifted higher from late July to early November awaiting the outcome of the U.S. election. Bond market reaction was swift and negative to the election results as President-Elect Trump's proposed policies of lower taxes and stimulus spending were perceived to be pro-growth/inflationary and therefore bad for bonds. Ten-year Treasury yields rose 0.40% in the week after the election and finished the year 0.59% higher than on election night. For the year, the 10-year Treasury yield was up 0.17%. Trump's election and the range of likely policy change, including the potential for a more aggressive FOMC, helped boost the U.S. Dollar Index by 3.6% for the fiscal period. Commodities, as measured by the Benchmark, posted their first positive year since 2010, rising in price by 11.77%. FUND PERFORMANCE The Fund's performance for the time period from January 1, 2016 to December 31, 2016 was positive 0.54% on a net asset value ("NAV") basis and 0.74% on a market price basis. The Benchmark returned 11.77% over the same period. Page 4 -------------------------------------------------------------------------------- PORTFOLIO COMMENTARY (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) ANNUAL REPORT DECEMBER 31, 2016 (UNAUDITED) The global commodity market is made up of several separate markets including agriculture, oil, industrial metals, and precious metals. These commodities are the building blocks of every economy in the world. Holding a physical commodity is not practical for most investors, but the futures market provides an alternative way to seek exposure to commodities. We believe individual commodity futures contracts and the unmanaged benchmarks that measure their performance offer attractive opportunities for investors to potentially diversify their portfolios and protect themselves against unforeseen rises in inflation; however, commodities and their benchmarks can be volatile. First Trust employs an investment style that seeks to control the Fund's risk profile to a relatively stable band, thus providing investors broadly diversified commodity exposure with more risk stability than traditional unmanaged commodity benchmarks. During the performance period, the Fund held allocations in 25 different commodities at various points in time. The Fund's average sector allocation was 16% energy, 11% industrial metals, 19% precious metals, 54% agricultural/livestock. As of December 31, 2016, the Fund held 18.5% in energy-related futures contracts, 15.7% in industrial metals, 9.0% in precious metals and 55.4% in agricultural/livestock products. Throughout the year, the Fund's overall sector exposures were relatively constant with the largest reallocation of dollars occurring in precious metals sector, where the Fund's positions changed from a 16.9% weighting at the end of 2015 to a 9.0% weighting at the end of 2016. The reallocation of dollars primarily flowed into the industrial metals sector which went from a 10.4% weight to a 15.7% weight. Relative to the Benchmark, the Fund generally held 10% to 23% less in energy futures contracts and 1% to 9% less in industrial metals. The Fund was overweight precious metals from January through December at which point the Fund went to an underweight in precious metals. The Fund was generally overweight the Agricultural and Livestock sectors by 2%-12% and 11%-17%, respectively. The primary driver of the Fund's relative underperformance to the Benchmark during the fiscal period was the Fund's underweight in energy-related commodities and the subsequent overweight to livestock-related commodities. Spot WTI crude prices began the year at $37.04/barrel before falling to a multi-year low on February 11, at $26.21/barrel. Prices then began a sharp rally which peaked at $54.06/barrel in late December, a rally of 106% off the bottom. Throughout the entire year, due to the high volatility of crude oil related commodities (WTI crude, Brent crude, gas-oil, heating oil, and gasoline) the Fund was underweight this sector resulting in substantial underperformance relative to the Fund's Benchmark. Further underperformance for the fiscal period was a result of the Fund's overweight to the livestock sector in the third quarter. During the third quarter, Lean Hog futures contracts for October delivery fell from 71.70 cents/lb. to 49.025 cents/lb., a 31.5% decline. In order to manage Fund volatility, the Fund was overweight Lean Hogs and underweight energy, resulting in a relative performance loss as Lean Hogs underperformed energy-related futures contracts in this time period. Please see the Consolidated Portfolio of Investments for a complete list of all positions within the portfolio as of December 31, 2016. MARKET AND FUND OUTLOOK Today, we believe the Fund is well positioned to achieve its investment objective. We believe that the Fund is currently broadly diversified across commodity futures and commodity sectors and that the risk control portfolio construction process is working well. Additionally, we believe that commodities are and will continue to be a valuable component of any well diversified portfolio. Because commodities are not highly correlated with traditional asset classes, they can potentially decrease portfolio volatility, enhance overall return, and provide meaningful diversification to an asset allocation strategy. Page 5 FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) UNDERSTANDING YOUR FUND EXPENSES DECEMBER 31, 2016 (UNAUDITED) As a shareholder of First Trust Global Tactical Commodity Strategy Fund (the "Fund"), you incur two types of costs: (1) transaction costs; and (2) ongoing costs, including management fees, distribution and/or service fees, if any, and other Fund expenses. This Example is intended to help you understand your ongoing costs (in U.S. dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other funds. The Example is based on an investment of $1,000 invested at the beginning of the period and held through the six-month period ended December 31, 2016. ACTUAL EXPENSES The first line in the following table provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled "Expenses Paid During the Six-Month Period" to estimate the expenses you paid on your account during this period. HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES The second line in the following table provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs such as brokerage commissions. Therefore, the second line in the table is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different funds. In addition, if these transactional costs were included, your costs would have been higher.
-------------------------------------------------------------------------------------------------------------------------- ANNUALIZED EXPENSE RATIO EXPENSES PAID BEGINNING ENDING BASED ON THE DURING THE ACCOUNT VALUE ACCOUNT VALUE SIX-MONTH SIX-MONTH JULY 1, 2016 DECEMBER 31, 2016 PERIOD PERIOD (a) -------------------------------------------------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) Actual $1,000.00 $ 946.70 0.95% $4.65 Hypothetical (5% return before expenses) $1,000.00 $1,020.36 0.95% $4.82
(a) Expenses are equal to the annualized expense ratio as indicated in the table, multiplied by the average account value over the period (July 1, 2016 through December 31, 2016), multiplied by 184/366 (to reflect the one-half year period). Page 6 FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) CONSOLIDATED PORTFOLIO OF INVESTMENTS DECEMBER 31, 2016 Besides the following listed futures contracts of the Fund's wholly-owned subsidiary, there were no investments held by the Fund at December 31, 2016. The following futures contracts of the Fund's wholly-owned subsidiary were open at December 31, 2016 (see Note 2B - Futures Contracts in the Notes to Consolidated Financial Statements):
UNREALIZED NUMBER NOTIONAL EXPIRATION APPRECIATION/ OF CONTRACTS VALUE DATE (DEPRECIATION) -------------------------------------------------------------------------------------------------------- FUTURES CONTRACTS LONG: -------------------------------------------------------------------------------------------------------- Brent Crude Futures 63 $ 3,320,445 Jan-17 $ 259,215 Cattle Feeder Futures 243 14,450,986 Jan-17 1,398,689 Cocoa Futures 612 15,267,225 Mar-17 (2,256,105) Coffee "C" Futures 42 2,247,791 Mar-17 (89,253) Copper Futures 232 14,639,980 Mar-17 (108,080) Corn Futures 265 4,710,473 Mar-17 (46,473) Cotton No. 2 Futures 439 15,678,898 Mar-17 (171,223) Gasoline RBOB Futures 106 7,129,449 Feb-17 378,404 Gold 100 Oz. Futures 70 8,361,161 Feb-17 (299,261) KC HRW Wheat Futures 197 4,052,542 Mar-17 69,683 Lean Hogs Futures 123 2,953,000 Feb-17 301,580 Lean Hogs Futures 201 4,911,260 Apr-17 561,970 Live Cattle Futures 248 11,198,922 Feb-17 313,238 Live Cattle Futures 41 1,799,051 Apr-17 79,979 LME Lead Futures 51 2,642,469 Jan-17 (88,006) LME Nickel Futures 19 1,299,402 Jan-17 (162,252) LME Primary Aluminum Futures 94 4,076,075 Jan-17 (95,175) LME Zinc Futures 132 9,199,612 Jan-17 (740,063) Low Sulphur Gasoil "G" Futures 128 5,940,228 Jan-17 472,572 Natural Gas Futures 282 9,932,157 Feb-17 456,723 NY Harbor ULSD Futures 98 6,661,281 Jan-17 451,990 Silver Futures 118 9,964,745 Mar-17 (531,235) Soybean Futures 284 14,890,651 May-17 (513,151) Soybean Meal Futures 30 972,860 Mar-17 (23,060) Soybean Oil Futures 320 7,067,560 Mar-17 (412,841) Sugar #11 (World) Futures 504 12,318,875 Feb-17 (1,305,870) WTI Crude Futures 32 1,735,874 Mar-17 37,886 -------------- -------------- $ 197,422,972 $ (2,060,119) ============== ==============
See Notes to Consolidated Financial Statements Page 7 FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) CONSOLIDATED PORTFOLIO OF INVESTMENTS (CONTINUED) DECEMBER 31, 2016 ----------------------------- VALUATION INPUTS A summary of the inputs used to value the Fund's investments as of December 31, 2016 is as follows (see Note 2A - Portfolio Valuation in the Notes to Consolidated Financial Statements):
ASSETS TABLE LEVEL 2 LEVEL 3 TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT VALUE AT QUOTED OBSERVABLE UNOBSERVABLE 12/31/2016 PRICES INPUTS INPUTS ------------ ------------ ------------ ------------ Futures Contracts................................... $ 4,781,929 $ 4,781,929 $ -- $ -- ============ ============ ============ ============ LIABILITIES TABLE LEVEL 2 LEVEL 3 TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT VALUE AT QUOTED OBSERVABLE UNOBSERVABLE 12/31/2016 PRICES INPUTS INPUTS ------------ ------------ ------------ ------------ Futures Contracts................................... $ (6,842,048) $ (6,842,048) $ -- $ -- ============ ============ ============ ============
All transfers in and out of the Levels during the period are assumed to be transferred on the last day of the period at their current value. There were no transfers between Levels at December 31, 2016. Page 8 See Notes to Consolidated Financial Statements FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES DECEMBER 31, 2016
ASSETS: Cash................................................................... $ 194,123,620 Cash segregated as collateral for open futures contracts............... 11,353,246 Receivables: Variation margin.................................................... 4,781,929 Due from broker..................................................... 2,178,796 Other assets........................................................... 3,072 -------------- Total Assets........................................................ 212,440,663 -------------- LIABILITIES: Payables: Variation margin.................................................... 6,842,048 Fund shares redeemed................................................ 6,143,775 Investment advisory fees............................................ 157,496 -------------- Total Liabilities................................................... 13,143,319 -------------- NET ASSETS............................................................. $ 199,297,344 ============== NET ASSETS CONSIST OF: Paid-in capital........................................................ $ 198,211,189 Par value.............................................................. 97,533 Accumulated net investment income (loss)............................... 3,048,741 Accumulated net realized gain (loss) on futures........................ -- Net unrealized appreciation (depreciation) on futures.................. (2,060,119) -------------- NET ASSETS............................................................. $ 199,297,344 ============== NET ASSET VALUE, per share............................................. $ 20.43 ============== Number of shares outstanding (unlimited number of shares authorized, par value $0.01 per share).............................. 9,753,334 ==============
See Notes to Consolidated Financial Statements Page 9 FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2016
INVESTMENT INCOME: Interest............................................................... $ 368,470 -------------- Total investment income............................................. 368,470 -------------- EXPENSES: Investment advisory fees............................................... 2,418,632 Interest expense on margin account..................................... 482 -------------- Total expenses...................................................... 2,419,114 -------------- NET INVESTMENT INCOME (LOSS)........................................... (2,050,644) -------------- NET REALIZED AND UNREALIZED GAIN (LOSS): Net realized gain (loss) on futures................................. (4,154,196) Net change in unrealized appreciation (depreciation) on futures..... 2,687,641 -------------- NET REALIZED AND UNREALIZED GAIN (LOSS)................................ (1,466,555) -------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS..................................................... $ (3,517,199) ==============
Page 10 See Notes to Consolidated Financial Statements FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
YEAR YEAR ENDED ENDED 12/31/2016 12/31/2015 -------------- -------------- OPERATIONS: Net investment income (loss)............................................. $ (2,050,644) $ (2,003,015) Net realized gain (loss)................................................. (4,154,196) (65,790,227) Net change in unrealized appreciation (depreciation)..................... 2,687,641 11,740,360 -------------- -------------- Net increase (decrease) in net assets resulting from operations.......... (3,517,199) (56,052,882) -------------- -------------- SHAREHOLDER TRANSACTIONS: Proceeds from shares sold................................................ 334,315,835 230,135,412 Cost of shares redeemed.................................................. (315,501,696) (165,991,671) -------------- -------------- Net increase (decrease) in net assets resulting from shareholder transactions.............................................. 18,814,139 64,143,741 -------------- -------------- Total increase (decrease) in net assets.................................. 15,296,940 8,090,859 NET ASSETS: Beginning of period...................................................... 184,000,404 175,909,545 -------------- -------------- End of period............................................................ $ 199,297,344 $ 184,000,404 ============== ============== Accumulated net investment income (loss) at end of period................ $ 3,048,741 $ (1,893,863) ============== ============== CHANGES IN SHARES OUTSTANDING: Shares outstanding, beginning of period.................................. 9,053,334 6,703,334 Shares sold.............................................................. 16,050,000 9,500,000 Shares redeemed.......................................................... (15,350,000) (7,150,000) -------------- -------------- Shares outstanding, end of period........................................ 9,753,334 9,053,334 ============== ==============
See Notes to Consolidated Financial Statements Page 11 FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) CONSOLIDATED FINANCIAL HIGHLIGHTS FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FOR THE PERIOD YEAR ENDED DECEMBER 31, 10/22/2013 (a) ---------------------------------------------- THROUGH 2016 2015 2014 12/31/2013 -------------- -------------- -------------- -------------- Net asset value, beginning of period........................... $ 20.32 $ 26.24 $ 29.78 $ 29.99 ---------- ---------- ---------- ---------- INCOME FROM INVESTMENT OPERATIONS: Net investment income (loss)................................... (0.20) (0.34) (0.38) (0.05) Net realized and unrealized gain (loss)........................ 0.31 (5.58) (3.16) (0.16) ---------- ---------- ---------- ---------- Total from investment operations............................... 0.11 (5.92) (3.54) (0.21) ---------- ---------- ---------- ---------- Net asset value, end of period................................. $ 20.43 $ 20.32 $ 26.24 $ 29.78 ========== ========== ========== ========== TOTAL RETURN (b)............................................... 0.54% (22.56)% (11.89)% (0.70)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (in 000's)........................... $ 199,297 $ 184,000 $ 175,910 $ 3,077 RATIOS TO AVERAGE NET ASSETS: Ratio of total expenses to average net assets.................. 0.95% 0.95% 0.95% 0.95% (c) Ratio of net investment income (loss) to average net assets.... (0.81)% (0.92)% (0.92)% (0.92)% (c) Portfolio turnover rate (d).................................... 0% 0% 0% 0%
(a) Inception date is consistent with the commencement of investment operations. First Trust Portfolios L.P. seeded the Fund on September 9, 2013, in order to provide initial capital required by SEC rules. (b) Total return is calculated assuming an initial investment made at the net asset value at the beginning of the period, reinvestment of all distributions at net asset value during the period, and redemption at net asset value on the last day of the period. The returns presented do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Total return is calculated for the time period presented and is not annualized for periods of less than a year. (c) Annualized. (d) Portfolio turnover is calculated for the time period presented and is not annualized for periods of less than a year and does not include securities received or delivered from processing creations or redemptions, derivatives and in-kind transactions. Page 12 See Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 1. ORGANIZATION First Trust Exchange-Traded Fund VII (the "Trust") is an open-end management investment company organized as a Massachusetts business trust on November 6, 2012, and is registered with the Securities and Exchange Commission ("SEC") under the Investment Company Act of 1940, as amended (the "1940 Act"). The Trust consists of two funds that are currently offering shares. This report covers the First Trust Global Tactical Commodity Strategy Fund (the "Fund"), a non-diversified series of the Trust, which trades under the ticker FTGC on The Nasdaq Stock Market LLC ("Nasdaq") and commenced operations on October 22, 2013. Unlike conventional mutual funds, the Fund issues and redeems shares on a continuous basis, at net asset value ("NAV"), only in large specified blocks consisting of 50,000 shares called a "Creation Unit." The Fund's Creation Units are generally issued and redeemed for cash, and in certain circumstances, in-kind for securities in which the Fund invests. Except when aggregated in Creation Units, the shares are not redeemable securities of the Fund. The Fund is an actively managed exchange-traded fund. The investment objective of the Fund is to seek to provide total return by providing investors with commodity exposure while seeking a relatively stable risk profile. Under normal market conditions, the Fund, through a wholly-owned subsidiary of the Fund, FT Cayman Subsidiary II (the "Subsidiary"), organized under the laws of the Cayman Islands, invests in a portfolio of commodity futures contracts and exchange-traded commodity linked instruments (collectively, "Commodities Instruments"). The Fund will not invest directly in Commodities Instruments. The Fund seeks to gain exposure to these investments exclusively by investing in the Subsidiary. The Fund's investment in the Subsidiary may not exceed 25% of the Fund's total assets at the end of each fiscal quarter. There can be no assurance that the Fund will achieve its investment objective. The Fund may not be appropriate for all investors. 2. SIGNIFICANT ACCOUNTING POLICIES The Fund is considered an investment company and follows accounting and reporting guidance under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 946, "Financial Services-Investment Companies." The consolidated financial statements include the accounts on a consolidated basis of the Subsidiary. All intercompany accounts and transactions have been eliminated in consolidation. The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of the consolidated financial statements. The preparation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. Actual results could differ from those estimates. A. PORTFOLIO VALUATION The Fund's NAV is determined daily as of the close of regular trading on the New York Stock Exchange ("NYSE"), normally 4:00 p.m. Eastern time, on each day the NYSE is open for trading. The Fund's NAV is calculated by dividing the value of all assets of the Fund (including accrued interest and dividends), less all liabilities (including accrued expenses and dividends declared but unpaid), by the total number of shares outstanding. The Fund's investments are valued daily at market value or, in the absence of market value with respect to any portfolio securities, at fair value. Market value prices represent last sale or official closing prices from a national or foreign exchange (i.e., a regulated market) and are primarily obtained from third-party pricing services. Fair value prices represent any prices not considered market value prices and are either obtained from a third-party pricing service or are determined by the Pricing Committee of the Fund's investment advisor, First Trust Advisors L.P. ("First Trust" or the "Advisor"), in accordance with valuation procedures adopted by the Trust's Board of Trustees, and in accordance with provisions of the 1940 Act. Investments valued by the Advisor's Pricing Committee, if any, are footnoted as such in the footnotes to the Consolidated Portfolio of Investments. The Fund's investments are valued as follows: Exchange-traded futures contracts are valued at the closing price in the market where such contracts are principally traded. If no closing price is available, exchange-traded futures contracts are fair valued at the mean of their most recent bid and asked price, if available, and otherwise at their closing bid price. If the Fund's investments are not able to be priced by their pre-established pricing methods, such investments may be valued by the Trust's Board of Trustees or its delegate, the Advisor's Pricing Committee, at fair value. A variety of factors may be considered in determining the fair value of such investments. Valuing the Fund's holdings using fair value pricing will result in using prices for those holdings that may differ from current market valuations. The Subsidiary's holdings will be valued in the same manner as the Fund's holdings. Page 13 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 The Fund is subject to fair value accounting standards that define fair value, establish the framework for measuring fair value and provide a three-level hierarchy for fair valuation based upon the inputs to the valuation as of the measurement date. The three levels of the fair value hierarchy are as follows: o Level 1 - Level 1 inputs are quoted prices in active markets for identical investments. An active market is a market in which transactions for the investment occur with sufficient frequency and volume to provide pricing information on an ongoing basis. o Level 2 - Level 2 inputs are observable inputs, either directly or indirectly, and include the following: o Quoted prices for similar investments in active markets. o Quoted prices for identical or similar investments in markets that are non-active. A non-active market is a market where there are few transactions for the investment, the prices are not current, or price quotations vary substantially either over time or among market makers, or in which little information is released publicly. o Inputs other than quoted prices that are observable for the investment (for example, interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates). o Inputs that are derived principally from or corroborated by observable market data by correlation or other means. o Level 3 - Level 3 inputs are unobservable inputs. Unobservable inputs may reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the investment. The inputs or methodologies used for valuing investments are not necessarily an indication of the risk associated with investing in those investments. A summary of the inputs used to value the Fund's investments as of December 31, 2016, is included with the Fund's Consolidated Portfolio of Investments. B. FUTURES CONTRACTS The Fund, through the Subsidiary, may purchase and sell exchange-listed commodity contracts. When the Subsidiary purchases a listed futures contract, it agrees to purchase a specified reference asset (e.g., commodity) at a specified future date. When the Subsidiary sells or shorts a listed futures contract, it agrees to sell a specified reference asset (e.g., commodity) at a specified future date. The price at which the purchase and sale will take place is fixed when the Subsidiary enters into the contract. The exchange clearing corporation is the ultimate counterparty for all exchange-listed contracts, so credit risk is limited to the creditworthiness of the exchange's clearing corporation. Margin deposits are posted as collateral with the clearing broker and, in turn, with the exchange clearing corporation. Exchange-listed commodity futures contracts are generally based upon commodities within the six principal commodity groups: energy, industrial metals, agriculture, precious metals, foods and fibers, and livestock. The price of a commodity futures contract will reflect the storage costs of purchasing the physical commodity. These storage costs include the time value of money invested in the physical commodity plus the actual costs of storing the commodity less any benefits from ownership of the physical commodity that are not obtained by the holder of a futures contract (this is sometimes referred to as the "convenience yield"). To the extent that these storage costs change for an underlying commodity while the Subsidiary is in a long position on that commodity, the value of the futures contract may change proportionately. Upon entering into a futures contract, the Subsidiary must deposit funds, called margin, with its custodian in the name of the clearing broker equal to a specified percentage of the current value of the contract. Open futures contracts are marked-to-market daily with the change in value recognized as a component of "Net change in unrealized appreciation (depreciation) on futures" on the Consolidated Statement of Operations. This daily fluctuation in value of the contracts is also known as variation margin and is included as "Variation margin" payable or receivable on the Consolidated Statement of Assets and Liabilities. When the Subsidiary purchases or sells a futures contract, the Subsidiary is required to collateralize its position in order to limit the risk associated with the use of leverage and other related risks. To collateralize its position, the Subsidiary segregates assets consisting of cash or liquid securities that, when added to any amounts deposited with a futures commission merchant as margin, are equal to the unrealized depreciation of the futures contract or otherwise collateralize its position in a manner consistent with the 1940 Act or the 1940 Act Rules and SEC interpretations thereunder. As the Subsidiary continues to engage in the described securities trading practices and properly segregates assets, the segregated assets will function as a practical limit on the amount of leverage which the Subsidiary may undertake and on the potential increase in the speculative character of the Subsidiary's outstanding portfolio investments. Additionally, such segregated assets generally ensure the availability of adequate funds to meet the obligations of the Subsidiary arising from such investment activities. C. CASH The Fund holds assets equal to or greater than the full notional exposure of the futures contracts. These assets may consist of cash and other short-term securities to comply with SEC guidance with respect to coverage of futures contracts by registered investment companies. Page 14 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 D. INVESTMENT TRANSACTIONS AND INVESTMENT INCOME Investment transactions are recorded as of the trade date. Realized gains and losses from investment transactions are recorded on the identified cost basis. Interest income, if any, is recorded on the accrual basis. E. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS Dividends from net investment income, if any, are declared and paid quarterly by the Fund. The Fund distributes its net realized capital gains, if any, to shareholders at least annually. Distributions in cash may be reinvested automatically in additional whole shares only if the broker through whom the shares were purchased makes such option available. Such shares will generally be reinvested by the broker based upon the market price of those shares and investors may be subject to customary brokerage commissions charged by the broker. Distributions from net investment income and realized capital gains are determined in accordance with income tax regulations, which may differ from U.S. GAAP. Certain capital accounts in the consolidated financial statements are periodically adjusted for permanent differences in order to reflect their tax character. These permanent differences are primarily due to the varying treatment of income and gain/loss on portfolio securities held by the Fund and have no impact on net assets or NAV per share. Temporary differences, which arise from recognizing certain items of income, expense and gain/loss in different periods for consolidated financial statement and tax purposes, will reverse at some time in the future. The Fund paid no distributions during the tax periods ended December 31, 2016 and 2015. As of December 31, 2016, the components of distributable earnings on a tax basis for the Fund were as follows: Undistributed Accumulated Net Unrealized Ordinary Capital and Appreciation Income Other Gains (Depreciation) --------------- --------------- --------------- $ -- $ (717,238) $ (1,342,881) F. INCOME TAXES The Fund intends to continue to qualify as a regulated investment company by complying with the requirements under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), which includes distributing substantially all of its net investment income and net realized gains to shareholders. Accordingly, no provision has been made for federal and state income taxes. However, due to the timing and amount of distributions, the Fund may be subject to an excise tax of 4% of the amount by which approximately 98% of the Fund's taxable income exceeds the distributions from such taxable income for the calendar year. The Subsidiary is classified as a controlled foreign corporation under Subchapter N of the Code. Therefore, the Fund is required to increase its taxable income by its share of the Subsidiary's income, whether or not such earnings are distributed by the Subsidiary to the Fund. Net investment losses of the Subsidiary cannot be deducted by the Fund in the current period nor carried forward to offset taxable income in future periods. The Fund intends to utilize provisions of the federal income tax laws, which allow it to carry a realized capital loss forward indefinitely following the year of the loss and offset such loss against any future realized capital gains. The Fund is subject to certain limitations under U.S. tax rules on the use of capital loss carryforwards and net unrealized built-in losses. These limitations apply when there has been a 50% change in ownership. At December 31, 2016, the Fund had no capital loss carryforwards outstanding for federal income tax purposes. The Fund is subject to accounting standards that establish a minimum threshold for recognizing, and a system for measuring, the benefits of a tax position taken or expected to be taken in a tax return. Taxable years ended 2013, 2014, 2015 and 2016 remain open to federal and state audit. As of December 31, 2016, management has evaluated the application of these standards to the Fund and has determined that no provision for income tax is required in the Fund's consolidated financial statements for uncertain tax positions. In order to present paid-in capital, accumulated net investment income (loss) and accumulated net realized gain (loss) on futures on the Consolidated Statement of Assets and Liabilities that more closely represent their tax character, certain adjustments have been made to paid-in capital, accumulated net investment income (loss) and accumulated net realized gain (loss) on Page 15 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 futures. These adjustments are primarily due to the difference between book and tax treatment of net investment income from the Subsidiary. The results of operations and net assets were not affected by these adjustments. For the year ended December 31, 2016, the adjustments for the Fund were as follows: Accumulated Accumulated Net Realized Net Investment Gain (Loss) Paid-in Income (Loss) on Futures Capital --------------- --------------- --------------- $ 6,993,248 $ 4,154,196 $ (11,147,444) G. EXPENSES Expenses, other than the investment advisory fee and other excluded expenses, are paid by First Trust (see Note 3). H. NEW AND AMENDED FINANCIAL REPORTING RULES AND FORMS On October 13, 2016, the SEC adopted new rules and forms, and amended existing rules and forms. The new and amended rules and forms are intended to modernize the reporting of information provided by funds and to improve the quality and type of information that funds provide to the SEC and investors. The new and amended rules and forms will be effective for the First Trust funds, including the Fund, for reporting periods beginning on and after June 1, 2018. Management is evaluating the new and amended rules and forms to determine the impact to the Fund. I. NEW ACCOUNTING PRONOUNCEMENT In December 2016, FASB released Accounting Standards Update ("ASU") 2016-19 that makes technical changes to various sections of the ASC, including Topic 820, Fair Value Measurement. The changes to Topic 820 are intended to clarify the difference between a valuation approach and a valuation technique. The changes to ASC 820-10-50-2 require a reporting entity to disclose, for Level 2 and Level 3 fair value measurements, a change in either or both a valuation approach and a valuation technique and the reason(s) for the change. The changes to Topic 820 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. At this time, management is evaluating the implications of the ASU and has not yet determined its impact on the consolidated financial statements and disclosures. 3. INVESTMENT ADVISORY FEE, AFFILIATED TRANSACTIONS AND OTHER FEE ARRANGEMENTS First Trust, the investment advisor to the Fund, is a limited partnership with one limited partner, Grace Partners of DuPage L.P., and one general partner, The Charger Corporation. The Charger Corporation is an Illinois corporation controlled by James A. Bowen, Chief Executive Officer of First Trust. First Trust is responsible for the selection and ongoing monitoring of the investments in the Fund's and the Subsidiary's portfolios, managing the Fund's business affairs and providing certain administrative services necessary for the management of the Fund. Pursuant to the Investment Management Agreement between the Trust and the Advisor, First Trust manages the investment of the Fund's assets and is responsible for the Fund's expenses, including the cost of transfer agency, custody, fund administration, legal, audit and other services, but excluding fee payments under the Investment Management Agreement, interest, taxes, brokerage commissions and other expenses connected with the execution of portfolio transactions, distribution and service fees pursuant to a 12b-1 plan, if any, and extraordinary expenses. The Fund has agreed to pay First Trust an annual unitary management fee equal to 0.95% of its average daily net assets. First Trust also provides fund reporting services to the Fund for a flat annual fee in the amount of $9,250, which is covered under the annual unitary management fee. The Subsidiary does not pay First Trust a separate management fee. The Trust has multiple service agreements with Brown Brothers Harriman & Co. ("BBH"). Under the service agreements, BBH performs custodial, fund accounting, certain administrative services, and transfer agency services for the Fund. As custodian, BBH is responsible for custody of the Fund's assets. As fund accountant and administrator, BBH is responsible for maintaining the books and records of the Fund's investments and cash. As transfer agent, BBH is responsible for maintaining shareholder records for the Fund. Each Trustee who is not an officer or employee of First Trust, any sub-advisor or any of their affiliates ("Independent Trustees") is paid a fixed annual retainer that is allocated equally among each fund in the First Trust Fund Complex. Each Independent Trustee is also paid an annual per fund fee that varies based on whether the fund is a closed-end or other actively managed fund, or is an index fund. Additionally, the Lead Independent Trustee and the Chairmen of the Audit Committee, Nominating and Governance Committee and Valuation Committee are paid annual fees to serve in such capacities, with such compensation allocated pro rata among each fund in the First Trust Fund Complex based on net assets. Independent Trustees are reimbursed for travel and out-of-pocket expenses in connection with all meetings. The Lead Independent Trustee and Committee Chairmen rotate every three years. The officers and "Interested" Trustee receive no compensation from the Trust for acting in such capacities. Page 16 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 4. PURCHASES AND SALES OF INVESTMENTS For the year ended December 31, 2016, the cost of purchases and proceeds from sales of investment securities, excluding short-term investments, derivatives and in-kind transactions, were $0 and $0, respectively. For the year ended December 31, 2016, the Fund did not have any in-kind purchases or sales. 5. DERIVATIVE TRANSACTIONS The following table presents the types of derivatives held by the Subsidiary at December 31, 2016, the primary underlying risk exposure and the location of these instruments as presented on the Consolidated Statement of Assets and Liabilities.
ASSET DERIVATIVES LIABILITY DERIVATIVES -------------------------------------------- -------------------------------------------- CONSOLIDATED CONSOLIDATED DERIVATIVE STATEMENT OF ASSETS AND STATEMENT OF ASSETS AND INSTRUMENT RISK EXPOSURE LIABILITIES LOCATION VALUE LIABILITIES LOCATION VALUE -------------- ---------------- ------------------------------ ----------- ------------------------------ ----------- Futures Commodity Risk Variation Margin Receivable $ 4,781,929 Variation Margin Payable $ 6,842,048
The following table presents the amount of net realized gain (loss) and change in net unrealized appreciation (depreciation) recognized for the year ended December 31, 2016, on derivative instruments, as well as the primary underlying risk exposure associated with each instrument. CONSOLIDATED STATEMENT OF OPERATIONS LOCATION ----------------------------------------------------------------------------- COMMODITY RISK EXPOSURE Net realized gain (loss) on futures $ (4,154,196) Net change in unrealized appreciation (depreciation) on futures 2,687,641 During the year ended December 31, 2016, the notional values of futures contracts opened and closed were $1,926,680,734 and $1,914,918,901, respectively. The Fund does not have the right to offset financial assets and financial liabilities related to futures contracts on the Consolidated Statement of Assets and Liabilities. 6. CREATIONS, REDEMPTIONS AND TRANSACTION FEES Shares are created and redeemed by the Fund only in Creation Unit size aggregations of 50,000 shares in transactions with broker-dealers or large institutional investors that have entered into a participation agreement (an "Authorized Participant"). In order to purchase Creation Units of the Fund, an Authorized Participant must deposit (i) a designated portfolio of securities determined by First Trust (the "Deposit Securities") and generally make or receive a cash payment referred to as the "Cash Component," which is an amount equal to the difference between the NAV of the Fund Shares (per Creation Unit Aggregation) and the market value of the Deposit Securities, and/or (ii) cash in lieu of all or a portion of the Deposit Securities. If the Cash Component is a positive number (i.e., the NAV per Creation Unit Aggregation exceeds the Deposit Amount), the Authorized Participant will deliver the Cash Component. If the Cash Component is a negative number (i.e., the NAV per Creation Unit Aggregation is less than the Deposit Amount), the Authorized Participant will receive the Cash Component. Authorized Participants purchasing Creation Units must pay to BBH, as transfer agent, a creation transaction fee (the "Creation Transaction Fee") regardless of the number of Creation Units purchased in the transaction. The Creation Transaction Fee is based on the composition of the securities included in the Fund's portfolio and the countries in which the transactions are settled. The Creation Transaction Fee is currently $500. The price for each Creation Unit will equal the daily NAV per share times the number of shares in a Creation Unit plus the fees described above and, if applicable, any operational processing and brokerage costs, transfer fees or stamp taxes. When the Fund permits an Authorized Participant to substitute cash or a different security in lieu of depositing one or more of the requisite Deposit Securities, the Authorized Participant may also be assessed an amount to cover the cost of purchasing the Deposit Securities and/or disposing of the substituted securities, including operational processing and brokerage costs, transfer fees, stamp taxes, and part or all of the spread between the expected bid and offer side of the market related to such Deposit Securities and/or substitute securities. Authorized Participants redeeming Creation Units must pay to BBH, as transfer agent, a redemption transaction fee (the "Redemption Transaction Fee"), regardless of the number of Creation Units redeemed in the transaction. The Redemption Transaction Fee may vary and is based on the composition of the securities included in the Fund's portfolio and the countries in which the transactions are settled. The Redemption Transaction Fee is currently $500. The Fund reserves the right to effect redemptions in cash. An Authorized Participant may request cash redemption in lieu of securities; however, the Fund may, in its discretion, reject any such request. Page 17 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 7. DISTRIBUTION PLAN The Board of Trustees adopted a Distribution and Service Plan pursuant to Rule 12b-1 under the 1940 Act. In accordance with the Rule 12b-1 plan, the Fund is authorized to pay an amount up to 0.25% of its average daily net assets each year to reimburse First Trust Portfolios L.P. ("FTP"), the distributor of the Fund, for amounts expended to finance activities primarily intended to result in the sale of Creation Units or the provision of investor services. FTP may also use this amount to compensate securities dealers or other persons that are Authorized Participants for providing distribution assistance, including broker-dealer and shareholder support and educational and promotional services. No 12b-1 fees are currently paid by the Fund, and pursuant to a contractual arrangement, no 12b-1 fees will be paid any time before April 30, 2018. 8. INDEMNIFICATION The Trust, on behalf of the Fund, has a variety of indemnification obligations under contracts with its service providers. The Trust's maximum exposure under these arrangements is unknown. However, the Trust has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. 9. SUBSEQUENT EVENTS Management has evaluated the impact of all subsequent events to the Fund through the date the consolidated financial statements were issued, and has determined that there was the following subsequent event: Effective January 3, 2017, the Chicago Mercantile Exchange ("CME") and LCH.Clearnet Limited ("LCH") amended their respective rulebooks to legally characterize variation margin payments -- for derivative contracts that are referred to as settled-to-market (STM) -- as settlements of the derivative's mark-to-market exposure and not collateral. These rulebook changes affect the entities that have derivatives cleared through the CME or LCH. Management is currently evaluating the impact, if any, of these rulebook changes to the Fund's consolidated financial statements and related disclosures. Page 18 -------------------------------------------------------------------------------- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM -------------------------------------------------------------------------------- TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST EXCHANGE-TRADED FUND VII: We have audited the accompanying consolidated statement of assets and liabilities of First Trust Global Tactical Commodity Strategy Fund and Subsidiary (the "Fund"), a series of the First Trust Exchange-Traded Fund VII, including the consolidated portfolio of investments, as of December 31, 2016, and the related consolidated statement of operations for the year then ended, the consolidated statements of changes in net assets for each of the two years in the period then ended, and the consolidated financial highlights for each of the periods presented. These consolidated financial statements and consolidated financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2016 by correspondence with the Fund's custodian and brokers. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements and consolidated financial highlights referred to above present fairly, in all material respects, the financial position of First Trust Global Tactical Commodity Strategy Fund and Subsidiary as of December 31, 2016, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the periods presented, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP Chicago, Illinois February 23, 2017 Page 19 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 (UNAUDITED) PROXY VOTING POLICIES AND PROCEDURES A description of the policies and procedures that the Trust uses to determine how to vote proxies and information on how the Fund voted proxies relating to portfolio investments during the most recent 12-month period ended June 30 is available (1) without charge, upon request, by calling (800) 988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; and (3) on the Securities and Exchange Commission's ("SEC") website located at http://www.sec.gov. PORTFOLIO HOLDINGS The Trust files its complete schedule of the Fund's portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Trust's Form N-Qs are available (1) by calling (800) 988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3) on the SEC's website at http://www.sec.gov; and (4) for review and copying at the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding the operation of the PRR may be obtained by calling (800) SEC-0330. TAX INFORMATION Of the ordinary income (including short-term capital gain) distributions made by the Fund during the year ended December 31, 2016, none qualify for the corporate dividends received deduction available to corporate shareholders or as qualified dividend income. RISK CONSIDERATIONS Risks are inherent in all investing. You should consider the Fund's investment objective, risks, charges and expenses carefully before investing. You can download the Fund's prospectus at http://www.ftportfolios.com or contact First Trust Portfolios L.P. at (800) 621-1675 to request a prospectus, which contains this and other information about the Fund. For additional information about the risks associated with investing in the Fund, please see the Fund's statement of additional information, as well as other regulatory filings. Read these documents carefully before you invest. First Trust Portfolios L.P. is the distributor of First Trust Exchange-Traded Fund VII. The following summarizes some of the risks that should be considered for the Fund. CASH TRANSACTION RISK. The Fund will, under most circumstances, effect a portion of creations and redemptions for cash, rather than in-kind securities. As a result, an investment in the Fund may be less tax-efficient than an investment in an exchange-traded fund that effects its creations and redemption for in-kind securities. Because the Fund may effect a portion of redemptions for cash, it may be required to sell portfolio securities in order to obtain the cash needed to distribute redemption proceeds. A sale of shares may result in capital gains or losses and may also result in higher brokerage costs. CLEARING BROKER RISK. The failure or bankruptcy of the Fund's and the Subsidiary's clearing broker could result in a substantial loss of Fund assets. Under current Commodity Futures Trading Commission ("CFTC") regulations, a clearing broker maintains customers' assets in a bulk segregated account. If a clearing broker fails to do so, or is unable to satisfy a substantial deficit in a customer account, its other customers may be subject to risk of loss of their funds in the event of that clearing broker's bankruptcy. In that event, the clearing broker's customers, such as the Fund and the Subsidiary, are entitled to recover, even in respect of property specifically traceable to them, only a proportional share of all property available for distribution to all of that clearing broker's customers. COMMODITY RISK. The value of Commodities Instruments typically is based upon the price movements of a physical commodity or an economic variable linked to such price movements. The prices of Commodities Instruments may fluctuate quickly and dramatically and may not correlate to price movements in other asset classes. An active trading market may not exist for certain commodities. Each of these factors and events could have a significant negative impact on the Fund. COUNTERPARTY RISK. The Fund bears the risk that the counterparty to a commodity, derivative or other contract with a third party may default on its obligations or otherwise fail to honor its obligations. If a counterparty defaults on its payment obligations the Fund will lose money and the value of an investment in Fund shares may decrease. In addition, the Fund may engage in such investment transactions with a limited number of counterparties. Page 20 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 (UNAUDITED) CREDIT RISK. Credit risk is the risk that an issuer of a security will be unable or unwilling to make dividend, interest and/or principal payments when due and the related risk that the value of a security may decline because of concerns about the issuer's ability to make such payments. CURRENCY EXCHANGE RATE RISK. The Fund may hold investments that are denominated in non-U.S. currencies, or in securities that provide exposure to such currencies, currency exchange rates or interest rates denominated in such currencies. Changes in currency exchange rates and the relative value of non-U.S. currencies will affect the value of the Fund's investment and the value of Fund shares. Currency exchange rates can be very volatile and can change quickly and unpredictably. As a result, the value of an investment in the Fund may change quickly and without warning and you may lose money. DERIVATIVES INVESTMENT RISK. The Fund, through the Subsidiary, invests in products generally referred to as "derivatives." Derivatives are financial instruments whose value depends upon, or is derived from, an underlying reference asset, such as a commodity, an index, or an interest or a currency exchange rate. Derivatives are subject to a number of risks described elsewhere in this prospectus, such as credit risk, interest rate risk and market risk. In addition, they involve the risk that changes in the value of the derivative may not correlate perfectly or substantially with the underlying asset, rate or index. Fund losses are likely to occur if the values do not correlate as expected. Derivatives can be volatile and may be less liquid than other securities. A lack of liquidity could result in the Fund being unable to close out a derivatives transaction in a cost-efficient manner. Moreover, unlike a publicly traded security for which the value is readily ascertainable, derivatives may at times be difficult to value. The use of derivatives can lead to losses because of adverse movements in the price or value of the underlying asset, index or rate, which may be magnified by certain features of the derivatives. Derivative instruments also involve the risk that the other party to the derivative transaction will not meet its obligations. These risks are heightened when derivatives are used to enhance the Fund's return or as a substitute for a position or security, rather than solely to hedge (or offset) the risk of a position or security held by the Fund. The Fund's use of certain derivatives may create investment leverage. This means that the derivative position may provide the Fund with investment exposure greater than the value of the Fund's investment in the derivative. As a result, these derivatives may magnify losses to the Fund, and even a small market movement may result in significant losses to the Fund. The risk of loss from certain short derivative positions is theoretically unlimited. The Fund may at times be required to liquidate portfolio positions, including when it is not advantageous to do so, in order to comply with the guidance from the Securities and Exchange Commission regarding asset segregation requirements to cover certain derivative positions. The success of the Fund's derivatives strategies will depend on the Advisor's ability to manage these sophisticated instruments. The U.S. government has recently enacted legislation which includes new regulation of derivatives markets. Because the legislation leaves much to rule making, and many rules are not yet final, the ultimate impact remains unclear. Regulatory changes could restrict the ability of the Fund and Subsidiary to engage in derivative transactions or increase the cost of these transactions, which may make it difficult or impossible for the Fund to pursue its investment strategy. ETF RISK. An ETF trades like common stock and represents a portfolio of securities. The risks of owning an ETF generally reflect the risks of owning the underlying securities, although lack of liquidity in an ETF could result in it being more volatile and ETFs have management fees that increase their costs. FOREIGN COMMODITY MARKETS RISK. The Fund, through the Subsidiary, engages in trading on commodity markets outside the United States on behalf of the Fund. Trading on such markets is not regulated by any United States government agency and may involve certain risks not applicable to trading on United States exchanges. The Fund may not have the same access to certain trades as do various other participants in foreign markets. Furthermore, as the Fund determines its net assets in United States dollars, with respect to trading in foreign markets the Fund is subject to the risk of fluctuations in the exchange rate between the local currency and dollars as well as the possibility of exchange controls. Certain futures contracts traded on foreign exchanges are treated differently for federal income tax purposes than are domestic contracts. FREQUENT TRADING RISK. The Fund regularly purchases and subsequently sells, i.e., "rolls," individual commodity futures contracts throughout the year so as to maintain a fully invested position. As the commodity contracts near their expiration dates, the Fund rolls them into new contracts. This frequent trading of contracts may increase the amount of commissions or mark-ups to broker-dealers that the Fund pays when it buys and sells contracts, which may detract from the Fund's performance. Page 21 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 (UNAUDITED) FUTURES RISK. The Fund invests in futures through the Subsidiary. All futures and futures-related products are highly volatile. Price movements are influenced by, among other things, changing supply and demand relationships; climate; government agricultural, trade, fiscal, monetary and exchange control programs and policies; national and international political and economic events; crop diseases; the purchasing and marketing programs of different nations; and changes in interest rates. In addition, governments from time to time intervene, directly and by regulation, in certain markets, particularly those in currencies. GAP RISK. The Fund is subject to the risk that a commodity price will change from one level to another with no trading in between. Usually such movements occur when there are adverse news announcements, which can cause a commodity price to drop substantially from the previous day's closing price. INCOME RISK. Income from the Fund's fixed income investments could decline during periods of falling interest rates. INTEREST RATE RISK. Interest rate risk is the risk that the value of the securities in the Fund will decline because of rising market interest rates. The Fund may be subject to a greater risk of rising interest rates than would normally be the case due to the recent period of historically low rates and the effect of potential government fiscal policy initiatives and resulting market reaction to those initiatives. Interest rate risk is generally lower for shorter-term investments and higher for longer-term investments. INVESTMENT COMPANIES RISK. The Fund may invest in securities of other investment companies, including ETFs. As a shareholder in other investment companies, the Fund will bear its ratable share of that investment company's expenses, and would remain subject to payment of the Fund's advisory and administrative fees with respect to assets so invested. In addition, the Fund will incur brokerage costs when purchasing and selling shares of ETFs or other exchange-traded investment companies. LIQUIDITY RISK. The Fund invests in Commodities Instruments, which may be less liquid than other types of investments. The illiquidity of Commodities Instruments could have a negative effect on the Fund's ability to achieve its investment objective and may result in losses to Fund shareholders. MANAGEMENT RISK. The Fund is subject to management risk because it is an actively managed portfolio. The Advisor will apply investment techniques and risk analyses in making investment decisions for the Fund, but there can be no guarantee that the Fund will meet its investment objective. MARKET RISK. The trading prices of commodities futures, fixed income securities and other instruments fluctuate in response to a variety of factors. The Fund's net asset value and market price may fluctuate significantly in response to these factors. As a result, an investor could lose money over short or long periods of time. NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the 1940 Act. As a result, the Fund is only limited as to the percentage of its assets that may be invested in the securities of any one issuer by the diversification requirements imposed by the Internal Revenue Code of 1986, as amended (the "Code"). The Fund may invest a relatively high percentage of its assets in a limited number of issuers. As a result, the Fund may be more susceptible to a single adverse economic or regulatory occurrence affecting one or more of these issuers, experience increased volatility and be highly invested in certain issuers. NON-U.S. INVESTMENT RISK. The Fund may invest in commodity futures contracts traded on non-U.S. exchanges or enter into over-the-counter derivative contracts with non-U.S. counterparties. Transactions on non-U.S. exchanges or with non-U.S. counterparties present risks because they may not be subject to the same degree of regulation as their U.S. counterparts. PORTFOLIO TURNOVER RISK. The Fund's strategy may frequently involve buying and selling portfolio securities by the Subsidiary to rebalance the Fund's exposure to various market sectors. The Subsidiary's higher portfolio turnover may result in the Fund paying higher levels of transaction costs and generating greater tax liabilities for shareholders. Portfolio turnover risk may cause the Fund's performance to be less than you expect. REGULATORY RISK. The Fund's investment decisions may need to be modified, and commodity contract positions held by the Fund may have to be liquidated at disadvantageous times or prices, to avoid exceeding any applicable position limits established by the CFTC, potentially subjecting the Fund to substantial losses. The regulation of commodity transactions in the United States is a rapidly changing area of law and is subject to ongoing modification by government, self-regulatory and judicial action. The effect of any future regulatory change with respect to any aspect of the Fund is impossible to predict, but could be substantial and adverse to the Fund. Page 22 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 (UNAUDITED) REPURCHASE AGREEMENT RISK. The Fund's investment in repurchase agreements may be subject to market and credit risk with respect to the collateral securing the repurchase agreements. Investments in repurchase agreements also may be subject to the risk that the market value of the underlying obligations may decline prior to the expiration of the repurchase agreement term. SHORT SALES RISK. The Fund may engage in "short sale" transactions. The Fund will lose value if the security or instrument that is the subject of a short sale increases in value. The Fund also may enter into a short derivative position through a futures contract. If the price of the security or derivative that is the subject of a short sale increases, then the Fund will incur a loss equal to the increase in price from the time that the short sale was entered into plus any premiums and interest paid to a third party in connection with the short sale. Therefore, short sales involve the risk that losses may be exaggerated, potentially losing more money than the actual cost of the investment. Also, there is the risk that the third party to the short sale may fail to honor its contract terms, causing a loss to the Fund. SUBSIDIARY INVESTMENT RISK. Changes in the laws of the United States and/or the Cayman Islands, under which the Fund and the Subsidiary are organized, respectively, could result in the inability of the Fund to operate as intended and could negatively affect the Fund and its shareholders. The Subsidiary is not registered under the 1940 Act and is not subject to all the investor protections of the 1940 Act. Thus, the Fund, as an investor in the Subsidiary, will not have all the protections offered to investors in registered investment companies. TAX RISK. The Fund intends to treat any income it may derive from Commodities Instruments (other than derivatives described in Revenue Rulings 2006 1 and 2006 31) received by the Subsidiary as "qualifying income" under the provisions of the Internal Revenue Code of 1986, as amended, applicable to "regulated investment companies" ("RICs"), based on a tax opinion received from special counsel which was based, in part, on numerous private letter rulings ("PLRs") provided to third parties not associated with the Fund or its affiliates (which only those parties may rely on as precedent). Shareholders and potential investors should be aware, however, that in September 2016 the Internal Revenue Service released proposed Regulations that, if finalized in the form proposed, would limit the qualifying income from the Subsidiary to the income distributed in the same year in which the income is required to be included in the income of the Fund under the controlled foreign corporation rules. The Fund intends to distribute the income in the same year as the income is required to be included, but a failure to do so could cause the Fund to have non-qualifying income and potentially lose RIC status. If the Fund did not qualify as a RIC for any taxable year and certain relief provisions were not available, the Fund's taxable income would be subject to tax at the Fund level and to a further tax at the shareholder level when such income is distributed. In such event, in order to re-qualify for taxation as a RIC, the Fund might be required to recognize unrealized gains, pay substantial taxes and interest and make certain distributions. This would cause investors to incur higher tax liabilities than they otherwise would have incurred and would have a negative impact on Fund returns. In such event, the Fund's Board of Trustees may determine to reorganize or close the Fund or materially change the Fund's investment objective and strategies. In the event that the Fund fails to qualify as a RIC, the Fund will promptly notify shareholders of the implications of the failure. The Fund may invest a portion of its assets in equity repurchase agreements. Recent changes in the law have the potential of changing the character and source of such instruments potentially subjecting them to unexpected U.S. taxation. Depending upon the terms of the contracts, the Fund may be required to indemnify the counterparty for such increased tax. U.S. GOVERNMENT AND AGENCY SECURITIES RISK. The Fund may invest in U.S. government obligations. U.S. government obligations include U.S. Treasury obligations and securities issued or guaranteed by various agencies of the U.S. government or by various instrumentalities which have been established or sponsored by the U.S. government. U.S. Treasury obligations are backed by the "full faith and credit" of the U.S. government. Securities issued or guaranteed by federal agencies and U.S. government sponsored instrumentalities may or may not be backed by the full faith and credit of the U.S. government. VOLATILITY RISK. Frequent or significant short-term price movements could adversely impact the performance of the Fund. In addition, the net asset value of the Fund over short-term periods may be more volatile than other investment options because of the Fund's significant use of financial instruments that have a leveraging effect. For example, because of the low margin deposits required, futures trading involves an extremely high degree of leverage and as a result, a relatively small price movement in a Commodities Instrument may result in immediate and substantial losses to the Fund. WHIPSAW MARKETS RISK. The Fund may be subject to the forces of "whipsaw" markets (as opposed to choppy or stable markets), in which significant price movements develop but then repeatedly reverse. Such market conditions could cause substantial losses to the Fund. Page 23 -------------------------------------------------------------------------------- BOARD OF TRUSTEES AND OFFICERS -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 (UNAUDITED) The Trust's statement of additional information includes additional information about the Trustees and is available, without charge, upon request, by calling (800) 988-5891.
NUMBER OF OTHER PORTFOLIOS IN TRUSTEESHIPS OR TERM OF OFFICE THE FIRST TRUST DIRECTORSHIPS NAME, ADDRESS, AND YEAR FIRST FUND COMPLEX HELD BY TRUSTEE DATE OF BIRTH AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING PAST POSITION WITH THE TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS ------------------------------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES ------------------------------------------------------------------------------------------------------------------------------------ Richard E. Erickson, Trustee o Indefinite Term Physician, Officer, Wheaton Orthopedics; 138 None c/o First Trust Advisors L.P. Limited Partner, Gundersen Real Estate 120 E. Liberty Drive, o Since Inception Limited Partnership (June 1992 to Suite 400 December 2016); Member, Sportsmed LLC Wheaton, IL 60187 to (April 2007 November 2015) D.O.B.: 04/51 Thomas R. Kadlec, Trustee o Indefinite Term President, ADM Investor Services, Inc. 138 Director of ADM c/o First Trust Advisors L.P. (Futures Commission Merchant) Investor Services, 120 E. Liberty Drive, o Since Inception Inc., ADM Suite 400 Investor Services Wheaton, IL 60187 International, and D.O.B.: 11/57 Futures Industry Association Robert F. Keith, Trustee o Indefinite Term President, Hibs Enterprises (Financial 138 Director of Trust c/o First Trust Advisors L.P. and Management Consulting) Company of 120 E. Liberty Drive, o Since Inception Illinois Suite 400 Wheaton, IL 60187 D.O.B.: 11/56 Niel B. Nielson, Trustee o Indefinite Term Managing Director and Chief Operating 138 Director of c/o First Trust Advisors L.P. Officer (January 2015 to Present), Covenant 120 E. Liberty Drive, o Since Inception Pelita Harapan Educational Foundation Transport, Inc. Suite 400 (Educational Products and Services); (May 2003 to Wheaton, IL 60187 President and Chief Executive Officer May 2014) D.O.B.: 03/54 (June 2012 to September 2014), Servant Interactive LLC (Educational Products and Services); President and Chief Executive Officer (June 2012 to September 2014), Dew Learning LLC (Educational Products and Services); President (June 2002 to June 2012), Covenant College ------------------------------------------------------------------------------------------------------------------------------------ INTERESTED TRUSTEE ------------------------------------------------------------------------------------------------------------------------------------ James A. Bowen(1), Trustee, o Indefinite Term Chief Executive Officer, First Trust 138 None Chairman of the Board Advisors L.P. and First Trust Portfolios 120 E. Liberty Drive, o Since Inception L.P.; Chairman of the Board of Suite 400 Directors, BondWave LLC (Software Wheaton, IL 60187 Development Company) and Stonebridge D.O.B.: 09/55 Advisors LLC (Investment Advisor)
----------------------------- (1) Mr. Bowen is deemed an "interested person" of the Trust due to his position as Chief Executive Officer of First Trust Advisors L.P., investment advisor of the Trust. Page 24 -------------------------------------------------------------------------------- BOARD OF TRUSTEES AND OFFICERS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 (UNAUDITED)
POSITION AND TERM OF OFFICE NAME, ADDRESS OFFICES AND LENGTH OF PRINCIPAL OCCUPATIONS AND DATE OF BIRTH WITH TRUST SERVICE DURING PAST 5 YEARS ------------------------------------------------------------------------------------------------------------------------------------ OFFICERS(2) ------------------------------------------------------------------------------------------------------------------------------------ James M. Dykas President and Chief o Indefinite Term Managing Director and Chief Financial Officer 120 E. Liberty Drive, Executive Officer (January 2016 to Present), Controller (January 2011 Suite 400 o Since January 2016 to January 2016), Senior Vice President (April 2007 Wheaton, IL 60187 to January 2016), First Trust Advisors L.P. and First D.O.B.: 01/66 Trust Portfolios L.P.; Chief Financial Officer (January 2016 to Present), BondWave LLC (Software Development Company) and Stonebridge Advisors LLC (Investment Advisor) Donald P. Swade Treasurer, Chief o Indefinite Term Senior Vice President (July 2016 to Present), Vice 120 E. Liberty Drive, Financial Officer and President (April 2012 to July 2016), First Trust Suite 400 Chief Accounting Officer o Since January 2016 Advisors L.P. and First Trust Portfolios L.P.; Vice Wheaton, IL 60187 President (September 2006 to April 2012), D.O.B.: 08/72 Guggenheim Funds Investment Advisors, LLC and Claymore Securities, Inc. W. Scott Jardine Secretary and Chief o Indefinite Term General Counsel, First Trust Advisors L.P. and First 120 E. Liberty Drive, Legal Officer Trust Portfolios L.P.; Secretary and General Suite 400 o Since Inception Counsel, BondWave LLC; Secretary, Stonebridge Wheaton, IL 60187 Advisors LLC D.O.B.: 05/60 Daniel J. Lindquist Vice President o Indefinite Term Managing Director (July 2012 to Present), Senior 120 E. Liberty Drive, Vice President (September 2005 to July 2012), First Suite 400 o Since Inception Trust Advisors L.P. and First Trust Portfolios L.P. Wheaton, IL 60187 D.O.B: 02/70 Kristi A. Maher Chief Compliance o Indefinite Term Deputy General Counsel, First Trust Advisors L.P. 120 E. Liberty Drive, Officer and Assistant and First Trust Portfolios L.P. Suite 400 Secretary o Since Inception Wheaton, IL 60187 D.O.B.: 12/66 Roger F. Testin Vice President o Indefinite Term Senior Vice President, First Trust Advisors L.P. and 120 E. Liberty Drive, First Trust Portfolios L.P. Suite 400 o Since Inception Wheaton, IL 60187 D.O.B.: 06/66 Stan Ueland Vice President o Indefinite Term Senior Vice President (September 2012 to Present), 120 E. Liberty Drive, Vice President (August 2005 to September 2012), Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios Wheaton, IL 60187 L.P. D.O.B.: 11/70
----------------------------- (2) The term "officer" means the president, vice president, secretary, treasurer, controller or any other officer who performs a policy making function. Page 25 -------------------------------------------------------------------------------- PRIVACY POLICY -------------------------------------------------------------------------------- FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC) DECEMBER 31, 2016 (UNAUDITED) PRIVACY POLICY First Trust values our relationship with you and considers your privacy an important priority in maintaining that relationship. We are committed to protecting the security and confidentiality of your personal information. SOURCES OF INFORMATION We collect nonpublic personal information about you from the following sources: o Information we receive from you and your broker-dealer, investment advisor or financial representative through interviews, applications, agreements or other forms; o Information about your transactions with us, our affiliates or others; o Information we receive from your inquiries by mail, e-mail or telephone; and o Information we collect on our website through the use of "cookies". For example, we may identify the pages on our website that your browser requests or visits. INFORMATION COLLECTED The type of data we collect may include your name, address, social security number, age, financial status, assets, income, tax information, retirement and estate plan information, transaction history, account balance, payment history, investment objectives, marital status, family relationships and other personal information. DISCLOSURE OF INFORMATION We do not disclose any nonpublic personal information about our customers or former customers to anyone, except as permitted by law. In addition to using this information to verify your identity (as required under law), the permitted uses may also include the disclosure of such information to unaffiliated companies for the following reasons: o In order to provide you with products and services and to effect transactions that you request or authorize, we may disclose your personal information as described above to unaffiliated financial service providers and other companies that perform administrative or other services on our behalf, such as transfer agents, custodians and trustees, or that assist us in the distribution of investor materials such as trustees, banks, financial representatives, proxy services, solicitors and printers. o We may release information we have about you if you direct us to do so, if we are compelled by law to do so, or in other legally limited circumstances (for example to protect your account from fraud). In addition, in order to alert you to our other financial products and services, we may share your personal information within First Trust. PRIVACY ONLINE We allow third-party companies, including AddThis (a social media sharing service), to collect certain anonymous information when you visit our website. These companies may use non-personally identifiable information during your visits to this and other websites in order to provide advertisements about goods and services likely to be of greater interest to you. These companies typically use a cookie, third party web beacon or pixel tags to collect this information. To learn more about this behavioral advertising practice, you can visit www.networkadvertising.org. CONFIDENTIALITY AND SECURITY With regard to our internal security procedures, we restrict access to your nonpublic personal information to those individuals who need to know that information to provide products or services to you. We maintain physical, electronic and procedural safeguards to protect your nonpublic personal information. POLICY UPDATES AND INQUIRIES As required by federal law, we will notify you of our privacy policy annually. We reserve the right to modify this policy at any time, however, if we do change it, we will tell you promptly. For questions about our policy, or for additional copies of this notice, please go to www.ftportfolios.com, or contact us at 1-800-621-1675 (First Trust Portfolios) or 1-800-222-6822 (First Trust Advisors). March 2016 Page 26 This page intentionally left blank. This page intentionally left blank. FIRST TRUST First Trust Exchange-Traded Fund VII INVESTMENT ADVISOR First Trust Advisors L.P. 120 E. Liberty Drive, Suite 400 Wheaton, IL 60187 ADMINISTRATOR, CUSTODIAN FUND ACCOUNTANT & TRANSFER AGENT Brown Brothers Harriman & Co. 50 Post Office Square Boston, MA 02110 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP 111 S. Wacker Drive Chicago, IL 60606 LEGAL COUNSEL Chapman and Cutler LLP 111 W. Monroe Street Chicago, IL 60603 [BLANK BACK COVER] FIRST TRUST First Trust Exchange-Traded Fund VII -------------------------------------------------------------------------------- First Trust Alternative Absolute Return Strategy ETF (FAAR) ---------------------------- Annual Report For the Period May 18, 2016 (Commencement of Operations) through December 31, 2016 ---------------------------- -------------------------------------------------------------------------------- TABLE OF CONTENTS -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) ANNUAL REPORT DECEMBER 31, 2016 Shareholder Letter......................................................... 1 Fund Performance Overview.................................................. 2 Portfolio Commentary....................................................... 4 Understanding Your Fund Expenses........................................... 6 Consolidated Portfolio of Investments...................................... 7 Consolidated Statement of Assets and Liabilities........................... 9 Consolidated Statement of Operations....................................... 10 Consolidated Statement of Changes in Net Assets............................ 11 Consolidated Financial Highlights.......................................... 12 Notes to Consolidated Financial Statements................................. 13 Report of Independent Registered Public Accounting Firm.................... 19 Additional Information..................................................... 20 Board of Trustees and Officers............................................. 25 Privacy Policy............................................................. 27 CAUTION REGARDING FORWARD-LOOKING STATEMENTS This report contains certain forward-looking statements within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements regarding the goals, beliefs, plans or current expectations of First Trust Advisors L.P. ("First Trust" or the "Advisor") and its representatives, taking into account the information currently available to them. Forward-looking statements include all statements that do not relate solely to current or historical fact. For example, forward-looking statements include the use of words such as "anticipate," "estimate," "intend," "expect," "believe," "plan," "may," "should," "would" or other words that convey uncertainty of future events or outcomes. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of First Trust Alternative Absolute Return Strategy ETF (the "Fund") to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. When evaluating the information included in this report, you are cautioned not to place undue reliance on these forward-looking statements, which reflect the judgment of the Advisor and its representatives only as of the date hereof. We undertake no obligation to publicly revise or update these forward-looking statements to reflect events and circumstances that arise after the date hereof. PERFORMANCE AND RISK DISCLOSURE There is no assurance that the Fund will achieve its investment objective. The Fund is subject to market risk, which is the possibility that the market values of investments owned by the Fund will decline and that the value of the Fund shares may therefore be less than what you paid for them. Accordingly, you can lose money investing in the Fund. See "Risk Considerations" in the Additional Information section of this report for a discussion of other risks of investing in the Fund. Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. For the most recent month-end performance figures, please visit http://www.ftportfolios.com or speak with your financial advisor. Investment returns, net asset value and share price will fluctuate and Fund shares, when sold, may be worth more or less than their original cost. The Advisor may also periodically provide additional information on Fund performance on the Fund's webpage at http://www.ftportfolios.com. HOW TO READ THIS REPORT This report contains information that may help you evaluate your investment in the Fund. It includes details about the Fund's portfolio and presents data and analysis that provide insight into the Fund's performance and investment approach. By reading the portfolio commentary from the portfolio management team of the Fund, you may obtain an understanding of how the market environment affected the Fund's performance. The statistical information that follows may help you understand the Fund's performance compared to that of relevant market benchmarks. It is important to keep in mind that the opinions expressed by personnel of the Advisor are just that: informed opinions. They should not be considered to be promises or advice. The opinions, like the statistics, cover the period through the date on the cover of this report. The material risks of investing in the Fund are spelled out in its prospectus, statement of additional information, this report and other Fund regulatory filings. -------------------------------------------------------------------------------- SHAREHOLDER LETTER -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) ANNUAL LETTER FROM THE CHAIRMAN AND CEO DECEMBER 31, 2016 Dear Shareholders: Now that 2016 is over, many will remember some of the historic events that occurred during the year: from the Brexit vote in the UK to leave the European Union, to the results of the U.S. Presidential Election which seemed unlikely at the beginning of the year, to the first World Series Championship for the Chicago Cubs in 108 years! First Trust Advisors L.P. ("First Trust") is pleased to provide you with this annual report for the First Trust Alternative Absolute Return Strategy ETF (the "Fund") which contains detailed information about your investment for the period of May 18, 2016 (the Fund's inception) through December 31, 2016, including a performance analysis and the financial statements for you to review. We encourage you to read this report and discuss it with your financial advisor. On November 8, Donald J. Trump was elected to become the 45th president in our country's history. While no one has a crystal ball and the ability to predict how his presidency will shape the United States (and the world), there is no doubt that his populist message resonated for many Americans. And his message of improving lives for the "average" American, while reducing the size and scope of the federal government, also won him millions of votes. Many of his supporters believe that with his background in business, President Trump will make policy changes that will continue to grow the economy and spur stock markets even higher. Many analysts predicted the Dow Jones Industrial Average would hit a new benchmark, 20,000, in the first days of the New Year. As with all change and a new administration, only time will tell. As of December 31, 2016, the S&P 500(R) Index was up 11.96% calendar year-to-date, on a total return basis, as measured by Bloomberg. The current bull market (measuring from March 9, 2009 through December 31, 2016) is the second longest in history. We remain bullish on the economy, but continue to have a long-term perspective. We believe investors should think long-term as well, since no one can predict volatility and the inevitable ups and downs that occur in the market. Thank you for your investment in the Fund and for giving First Trust the opportunity to be a part of your investment plan. We value our relationship with you and will continue our relentless focus on bringing the types of investments that we believe could help you reach your financial goals. Sincerely, /s/ James A. Bowen James A. Bowen Chairman of the Board of Trustees Chief Executive Officer of First Trust Advisors L.P. Page 1 -------------------------------------------------------------------------------- FUND PERFORMANCE OVERVIEW (UNAUDITED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) The First Trust Alternative Absolute Return Strategy ETF (the "Fund") seeks to provide investors with long-term total return. The shares of the Fund are listed and trade on The Nasdaq Stock Market LLC under the ticker symbol "FAAR." The Fund is an actively managed exchange-traded fund that seeks to achieve long-term total return through long and short investments in exchange-traded commodity futures contracts ("Commodity Futures") through a wholly-owned subsidiary of the Fund organized under the laws of the Cayman Islands (the "Subsidiary"). The Fund will not invest directly in Commodity Futures. The Fund expects to gain exposure to these investments exclusively by investing in the Subsidiary. The Subsidiary is advised by First Trust Advisors L.P., the Fund's investment advisor. The Fund's investment in the Subsidiary is intended to provide the Fund with exposure to commodity markets within the limits of current federal income tax laws applicable to investment companies such as the Fund, which limit the ability of investment companies to invest directly in Commodity Futures. The Subsidiary has the same investment objective as the Fund, but unlike the Fund, it may invest without limitation in Commodity Futures. The Fund will invest up to 25% of its total assets in the Subsidiary. The Subsidiary's holdings will primarily consist of Commodity Futures, which are contractual agreements to buy or sell a particular commodity or financial instrument at a pre-determined price at a settlement date in the future. The Fund, through the Subsidiary, engages in trading on commodity markets both inside and outside of the United States on behalf of the Fund. The Fund, through the Subsidiary, may invest in a range of Commodity Futures and markets as determined by the Fund's investment advisor from time to time. The remainder of the Fund's assets will primarily be invested in: (1) U.S. government and agency securities with maturities of five years or less; (2) short-term repurchase agreements; (3) money market instruments; and (4) cash. The Fund uses such instruments as investments and to collateralize the Subsidiary's Commodity Futures exposure on a day-to-day basis.
-------------------------------------------------------------------------------------------------------------------- PERFORMANCE -------------------------------------------------------------------------------------------------------------------- CUMULATIVE TOTAL RETURNS Inception (5/18/16) to 12/31/16 FUND PERFORMANCE NAV -5.17% Market Price -5.00% INDEX PERFORMANCE 3 Month U.S. Treasury Bills + 3% 2.11% Bloomberg Commodity Index 2.70% S&P 500(R) Index 10.78% --------------------------------------------------------------------------------------------------------------------
Total returns for the period since inception are calculated from the inception date of the Fund. "Cumulative total returns" represent the total change in value of an investment over the period indicated. The Fund's per share net asset value ("NAV") is the value of one share of the Fund and is computed by dividing the value of all assets of the Fund (including accrued interest and dividends), less all liabilities (including accrued expenses and dividends declared but unpaid), by the total number of outstanding shares. The price used to calculate market return ("Market Price") is determined by using the midpoint between the highest bid and the lowest offer on the stock exchange on which shares of the Fund are listed for trading as of the time that the Fund's NAV is calculated. Since shares of the Fund did not trade in the secondary market until after its inception, for the period from inception to the first day of secondary market trading in shares of the Fund, the NAV of the Fund is used as a proxy for the secondary market trading price to calculate market returns. NAV and market returns assume that all dividend distributions have been reinvested in the Fund at NAV and Market Price, respectively. An index is a statistical composite that tracks a specified financial market or sector. Unlike the Fund, indices do not actually hold a portfolio of securities and therefore do not incur the expenses incurred by the Fund. These expenses negatively impact the performance of the Fund. Also, index returns do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, index returns would be lower. The total returns presented reflect the reinvestment of dividends on securities in the indices. The returns presented do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. The investment return and principal value of shares of the Fund will vary with changes in market conditions. Shares of the Fund may be worth more or less than their original cost when they are redeemed or sold in the market. The Fund's past performance is no guarantee of future performance. Page 2 -------------------------------------------------------------------------------- FUND PERFORMANCE OVERVIEW (UNAUDITED) (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) (CONTINUED)
---------------------------------------------------------------------------------------------- PERFORMANCE OF A $10,000 INITIAL INVESTMENT MAY 18, 2016 - DECEMBER 31, 2016 First Trust Alternative Absolute Return 3 Month U.S. Bloomberg S&P 500(R) Strategy ETF (FAAR) Treasury Bills + 3% Commodity Index Index 5/18/16 $10,000 $10,000 $10,000 $10,000 6/30/16 9,930 10,041 10,407 10,274 12/31/16 9,483 10,212 10,271 11,077 ----------------------------------------------------------------------------------------------
Performance figures assume reinvestment of all distributions and do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. An index is a statistical composite that tracks a specified financial market or sector. Unlike the Fund, the indices do not actually hold a portfolio of investments and therefore do not incur the expenses incurred by the Fund. These expenses negatively impact the performance of the Fund. The Fund's past performance does not predict future performance. FREQUENCY DISTRIBUTION OF DISCOUNTS AND PREMIUMS BID/ASK MIDPOINT VS. NAV THROUGH DECEMBER 31, 2016 The following Frequency Distribution of Discounts and Premiums charts are provided to show the frequency at which the bid/ask midpoint price for the Fund was at a discount or premium to the daily NAV. The following tables are for comparative purposes only and represent the period May 19, 2016 (commencement of trading) through December 31, 2016. Shareholders may pay more than NAV when they buy Fund shares and receive less than NAV when they sell those shares because shares are bought and sold at current market price. Data presented represents past performance and cannot be used to predict future results. -------------------------------------------------------------------------------- NUMBER OF DAYS BID/ASK MIDPOINT AT/ABOVE NAV -------------------------------------------------------------------------------- FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00% 5/19/16 - 12/31/16 72 40 0 0 -------------------------------------------------------------------------------- NUMBER OF DAYS BID/ASK MIDPOINT BELOW NAV -------------------------------------------------------------------------------- FOR THE PERIOD 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00% 5/19/16 - 12/31/16 27 16 2 0 Page 3 -------------------------------------------------------------------------------- PORTFOLIO COMMENTARY -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) ANNUAL REPORT DECEMBER 31, 2016 (UNAUDITED) INVESTMENT ADVISOR First Trust Advisors L.P. ("First Trust"), located in Wheaton, Illinois, is the investment advisor, commodity pool operator and commodity trading advisor to the First Trust Alternative Absolute Return Strategy ETF (the "Fund" or "FAAR"). In this capacity, First Trust is responsible for the selection and ongoing monitoring of the investments in the Fund's portfolio and certain other services necessary for the management of the portfolio. First Trust serves as advisor for four mutual fund portfolios, ten exchange-traded funds consisting of 114 series, 16 closed-end funds, a variable insurance trust consisting of three series and is also the portfolio supervisor of certain unit investment trusts sponsored by First Trust Portfolios L.P. ("FTP"), also located in Wheaton, Illinois. PORTFOLIO MANAGEMENT TEAM JOHN GAMBLA - CFA, FRM, PRM, SENIOR PORTFOLIO MANAGER ROB A. GUTTSCHOW - CFA, SENIOR PORTFOLIO MANAGER COMMENTARY The First Trust Alternative Absolute Return Strategy ETF (the "Fund") is an actively managed exchange-traded fund. The Fund's primary investment objective is to seek to provide investors with long-term total return. For performance measurement, the Fund is benchmarked to the unmanaged Bloomberg Commodity Index, the Three Month U.S. Treasury Bills return + 3.0%, and the S&P 500(R) Index. This commentary discusses the markets performance for the calendar year of 2016 and the Fund's performance during its fiscal period from the Fund's inception date of May 18, 2016 through December 31, 2016. OVERALL MARKET RECAP U.S. economic growth was modest during the fiscal period ended December 31, 2016, with U.S. GDP growth estimated to be 2.0% annualized. The unemployment rate declined throughout the year, falling from 5.0% to 4.7% during the fiscal period. The total number of non-farm payroll jobs added to the U.S. economy during the fiscal period, as measured by the Bureau of Labor Statistics, was approximately 2.16mm. The overall steady performance of the U.S. economy and the slight improvement in the unemployment rate, combined with a patient, wait-and-see approach by the Federal Reserve Open Market Committee (FOMC), boosted equity markets throughout the year. These factors thereby lifted U.S. equity markets (S&P 500(R), the "Index") to a total return of 11.96% for the fiscal period. While negative for the first two months of 2016, equities were up the remainder of the year on improving earnings forecasts. The surprise Brexit vote in late June, where voters in the UK chose to leave the European Union, created a short bout of downward volatility that was quickly erased in July. Equity markets drifted sideways to downward from July to November as the results of the U.S. election were eagerly awaited. Perhaps as shocking as the Brexit vote, Donald Trump won a clear majority in the Electoral College, sparking a two month rally that added 5.0% to the Index's total return for the year. Throughout the year, bond prices rallied as the FOMC pushed potential rate hikes further into the future. Rates on the ten-year U.S. Treasury reached a fiscal period low in early July at 1.35%. Similar to equities, bond yields then drifted higher from late July to early November awaiting the outcome of the U.S. election. Bond market reaction was swift and negative to the election results as President-Elect Trump's proposed policies of lower taxes and stimulus spending were perceived to be pro-growth/inflationary and therefore bad for bonds. Ten-year treasury yields rose 0.40% in the week after the election and finished the year 0.59% higher than on election night. For the year, the ten-year yield was up 0.17%. Trump's election and the range of likely policy changes, including the potential for a more aggressive FOMC, helped boost the U.S. Dollar Index by 3.6% for the fiscal period. Commodities, as measured by the Bloomberg Commodity Index, posted their first positive year since 2010, rising in price by 11.77%. FUND PERFORMANCE The Fund's performance from its inception on May 18, 2016 through December 31, 2016 was -5.17% on an NAV basis and -5.00% on a market price basis. The Fund's benchmarks, (Bloomberg Commodity Index, 3 Month U.S. Treasury Bills + 3.0%, and S&P 500(R) Index) returned 2.70%, 2.11%, and 10.78%, respectively. Page 4 -------------------------------------------------------------------------------- PORTFOLIO COMMENTARY (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) ANNUAL REPORT DECEMBER 31, 2016 (UNAUDITED) The global commodity market is made up of several separate markets including agriculture, livestock, energy, industrial metals, and precious metals. These commodities are the building blocks of every economy in the world, in our view. Holding a physical commodity may not be practical for most investors, but the futures market provides an alternative way to seek exposure to commodities. The Fund employs an investment style that seeks to profit from rising and falling commodity prices by purchasing futures contracts in commodities that are anticipated to rise in price and shorting or selling futures contracts in commodities that are anticipated to fall in price. Commodities and their respective futures contracts can be very volatile in price and there is no guarantee that the Fund managers will correctly anticipate which commodity futures contracts will rise or fall in price. During the performance period, the Fund held allocations in 26 different commodities contracts. The Fund's average long and short exposure during the period was 54.8% and -23.8%, respectively. The average gross (long positions + absolute value of short positions) was 78.6% and the average net exposure was positive 31.0%. The average gross sector allocations were 12% energy, 7% industrial metals, 4% precious metals, 41% agricultural, and 14% livestock. As of December 31, 2016, the Fund's gross exposure was 78.6%, comprised of 54.8% long positions and 23.8% short positions. The Fund's largest exposure was a 9.0% long position in feeder cattle with the second largest exposure being an 8.1% short position in CBOT wheat. The Fund's best performing allocations during the fiscal period were short positions in CBOE wheat and Kansas wheat, where the Fund maintained short positions averaging 5.8% and 4.7% of NAV throughout. During the fiscal period, the Bloomberg Total Return indexes for CBOE wheat and Kansas wheat where down 23.9% and 19.9%, respectively. Other positions which added value to the Fund's performance were tin and nickel, as industrial metals prices rallied in the fiscal period and the Fund correctly positioned itself on the long side of the market. Offsetting the positive returns from the above, the Fund was long cocoa which fell in price by 25% (Bloomberg Cocoa Total Return Index) during the fiscal period. The Fund averaged a 6.5% long position in cocoa during the fiscal period. Natural gas also contributed to the Fund's negative performance as the Fund traded on the long and short side of the market. Natural gas rallied strongly from the Fund's inception date through the end of June, with the Fund positioned incorrectly on the short side of the market, resulting in negative performance. In early October, the Fund traded into a small long position in natural gas, in anticipation of a continuation of the summer rally, only to see prices fall dramatically through mid-November and then rally back in late November and December. Other positions that subtracted from returns during the fiscal period were positions in corn, soymeal, and feeder cattle, all of which rallied in the first half of the year only to fall in price the second half of the year. Please see the Fund's Consolidated Portfolio of Investments for a complete list of all positions within the portfolio as of December 31, 2016. MARKET AND FUND OUTLOOK Today, we believe the Fund is well-positioned to achieve its investment objective of seeking to provide investors with long-term total return. We believe that the Fund is currently broadly diversified across commodity futures and commodity sectors with a variety of long and short positions in anticipation of rising and falling prices. Additionally, we believe that the investment strategy employed by the Fund results in long / short commodity exposures that are not highly correlated to long positons in stock, bonds, or commodities; therefore, we believe the Fund could potentially decrease portfolio volatility, enhance overall return, and provide meaningful diversification to an asset allocation strategy. Page 5 FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) UNDERSTANDING YOUR FUND EXPENSES DECEMBER 31, 2016 (UNAUDITED) As a shareholder of First Trust Alternative Absolute Return Strategy ETF (the "Fund"), you incur two types of costs: (1) transaction costs; and (2) ongoing costs, including management fees, distribution and/or service fees, if any, and other Fund expenses. This Example is intended to help you understand your ongoing costs (in U.S. dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other funds. The Example is based on an investment of $1,000 invested at the beginning of the period (or since inception) and held through the six-month period ended December 31, 2016. ACTUAL EXPENSES The first line in the following table provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled "Expenses Paid During the Six-Month Period" to estimate the expenses you paid on your account during this period. HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES The second line in the following table provides information about hypothetical account values and hypothetical expenses based on the Fund's actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund's actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Fund and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs such as brokerage commissions. Therefore, the second line in the table is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different funds. In addition, if these transactional costs were included, your costs would have been higher.
-------------------------------------------------------------------------------------------------------------------------- ANNUALIZED EXPENSE RATIO EXPENSES PAID BEGINNING ENDING BASED ON THE DURING THE ACCOUNT VALUE ACCOUNT VALUE SIX-MONTH SIX-MONTH JULY 1, 2016 DECEMBER 31, 2016 PERIOD PERIOD (a) -------------------------------------------------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) Actual $1,000.00 $ 955.00 0.95% $4.67 Hypothetical (5% return before expenses) $1,000.00 $1,020.36 0.95% $4.82
(a) Expenses are equal to the annualized expense ratio as indicated in the table, multiplied by the average account value over the period (July 1, 2016 through December 31, 2016), multiplied by 184/366 (to reflect the one-half year period). Page 6 FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) CONSOLIDATED PORTFOLIO OF INVESTMENTS DECEMBER 31, 2016 Besides the following listed futures contracts of the Fund's wholly-owned subsidiary, there were no investments held by the Fund at December 31, 2016. The following futures contracts of the Fund's wholly-owned subsidiary were open at December 31, 2016 (see Note 2B - Futures Contracts in the Notes to Consolidated Financial Statements):
UNREALIZED NUMBER NOTIONAL EXPIRATION APPRECIATION/ OF CONTRACTS VALUE DATE (DEPRECIATION) -------------------------------------------------------------------------------------------------------- FUTURES CONTRACTS LONG: -------------------------------------------------------------------------------------------------------- Cattle Feeder Futures 3 $ 183,911 Jan-17 $ 11,764 Cattle Feeder Futures 1 58,656 Mar-17 3,894 Cocoa Futures 6 148,876 Mar-17 (21,316) Coffee "C" Futures 1 61,106 Mar-17 (9,712) Copper Futures 1 63,900 Mar-17 (1,263) Cotton No.2 Futures 6 212,631 Mar-17 (681) Lean Hogs Futures 2 51,720 Feb-17 1,200 Live Cattle Futures 1 43,879 Apr-17 1,951 Live Cattle Futures 2 90,686 Feb-17 2,154 LME Primary Aluminum Futures 2 86,163 Jan-17 (1,462) LME Zinc Futures 1 63,238 Jan-17 850 Low Sulphur Gasoil "G" Futures 1 48,725 Jan-17 1,375 Natural Gas Futures 2 72,880 Feb-17 800 Silver Futures 2 164,845 Mar-17 (4,955) Soybean Futures 4 208,125 May-17 (5,625) Soybean Meal Futures 3 97,449 Mar-17 (2,469) Soybean Oil Futures 2 42,073 Mar-17 (481) Sugar #11 (World) Futures 3 71,747 Feb-17 (6,194) -------------- -------------- $ 1,770,610 $ (30,170) -------------- -------------- -------------------------------------------------------------------------------------------------------- FUTURES CONTRACTS SHORT: -------------------------------------------------------------------------------------------------------- Brent Crude Futures 1 $ (55,540) Jan-17 $ (1,280) Corn Futures 1 (17,488) Mar-17 (112) KC HRW Wheat Futures 6 (128,603) Mar-17 3,053 Wheat Futures 11 (238,660) May-17 7,385 WTI Crude Futures 1 (52,120) Jan-17 (1,600) -------------- -------------- $ (492,411) $ 7,446 -------------- -------------- TOTAL $ 1,278,199 $ (22,724) ============== ==============
See Notes to Consolidated Financial Statements Page 7 FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) CONSOLIDATED PORTFOLIO OF INVESTMENTS (CONTINUED) DECEMBER 31, 2016 ----------------------------- VALUATION INPUTS A summary of the inputs used to value the Fund's investments as of December 31, 2016 is as follows (see Note 2A - Portfolio Valuation in the Notes to Consolidated Financial Statements):
ASSETS TABLE LEVEL 2 LEVEL 3 TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT VALUE AT QUOTED OBSERVABLE UNOBSERVABLE 12/31/2016 PRICES INPUTS INPUTS ------------ ------------ ------------ ------------ Futures Contracts................................... $ 34,426 $ 34,426 $ -- $ -- ============ ============ ============ ============ LIABILITIES TABLE LEVEL 2 LEVEL 3 TOTAL LEVEL 1 SIGNIFICANT SIGNIFICANT VALUE AT QUOTED OBSERVABLE UNOBSERVABLE 12/31/2016 PRICES INPUTS INPUTS ------------ ------------ ------------ ------------ Futures Contracts................................... $ (57,150) $ (57,150) $ -- $ -- ============ ============ ============ ============
All transfers in and out of the Levels during the period are assumed to be transferred on the last day of the period at their current value. There were no transfers between Levels at December 31, 2016. Page 8 See Notes to Consolidated Financial Statements FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES DECEMBER 31, 2016
ASSETS: Cash................................................................... $ 2,738,038 Cash segregated as collateral for open futures contracts............... 112,548 Receivables: Variation margin.................................................... 34,426 Due from broker..................................................... 19,498 -------------- Total Assets........................................................ 2,904,510 ============== LIABILITIES: Payables: Variation margin.................................................... 57,150 Investment advisory fees............................................ 2,314 -------------- Total Liabilities................................................... 59,464 -------------- NET ASSETS............................................................. $ 2,845,046 ============== NET ASSETS CONSIST OF: Paid-in capital........................................................ $ 2,899,079 Par value.............................................................. 1,000 Accumulated net investment income (loss)............................... (32,309) Accumulated net realized gain (loss) on futures........................ -- Net unrealized appreciation (depreciation) on futures.................. (22,724) -------------- NET ASSETS............................................................. $ 2,845,046 ============== NET ASSET VALUE, per share............................................. $ 28.45 ============== Number of shares outstanding (unlimited number of shares authorized, par value $0.01 per share).............................. 100,002 ==============
See Notes to Consolidated Financial Statements Page 9 FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) CONSOLIDATED STATEMENT OF OPERATIONS FOR THE PERIOD MAY 18, 2016 (a) THROUGH DECEMBER 31, 2016
INVESTMENT INCOME: Interest............................................................... $ 2,391 -------------- Total investment income............................................. 2,391 -------------- EXPENSES: Investment advisory fees............................................... 17,244 -------------- Total expenses...................................................... 17,244 -------------- NET INVESTMENT INCOME (LOSS)........................................... (14,853) -------------- NET REALIZED AND UNREALIZED GAIN (LOSS): Net realized gain (loss) on futures................................. (117,437) Net change in unrealized appreciation (depreciation) on futures..... (22,724) -------------- NET REALIZED AND UNREALIZED GAIN (LOSS)................................ (140,161) -------------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS..................................................... $ (155,014) ==============
(a) Inception date is consistent with the commencement of investment operations and is the date the initial creation unit was established. First Trust Portfolios L.P. seeded the Fund on May 9, 2016, in order to provide initial capital required by SEC rules. Page 10 See Notes to Consolidated Financial Statements FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS FOR THE PERIOD MAY 18, 2016 (a) THROUGH DECEMBER 31, 2016
OPERATIONS: Net investment income (loss)........................................ $ (14,853) Net realized gain (loss)............................................ (117,437) Net change in unrealized appreciation (depreciation)................ (22,724) -------------- Net increase (decrease) in net assets resulting from operations..... (155,014) -------------- SHAREHOLDER TRANSACTIONS: Proceeds from shares sold........................................... 3,000,060 -------------- Net increase (decrease) in net assets resulting from shareholder transactions..................................................... 3,000,060 -------------- Total increase (decrease) in net assets............................. 2,845,046 NET ASSETS: Beginning of year................................................... -- -------------- End of year......................................................... $ 2,845,046 ============== Accumulated net investment income (loss) at end of period........... $ (32,309) ============== CHANGES IN SHARES OUTSTANDING: Shares outstanding, beginning of period............................. -- Shares sold......................................................... 100,002 -------------- Shares outstanding, end of period................................... 100,002 ==============
(a) Inception date is consistent with the commencement of investment operations and is the date the initial creation unit was established. First Trust Portfolios L.P. seeded the Fund on May 9, 2016, in order to provide initial capital required by SEC rules. See Notes to Consolidated Financial Statements Page 11 FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) CONSOLIDATED FINANCIAL HIGHLIGHTS FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD
FOR THE PERIOD 5/18/2016 (a) THROUGH 12/31/2016 -------------- Net asset value, beginning of period............................ $ 30.00 ---------- INCOME FROM INVESTMENT OPERATIONS: Net investment income (loss).................................... (0.15) Net realized and unrealized gain (loss)......................... (1.40) ---------- Total from investment operations................................ (1.55) ---------- Net asset value, end of period.................................. $ 28.45 ========== TOTAL RETURN (b)................................................ (5.17)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (in 000's)............................ $ 2,845 RATIOS TO AVERAGE NET ASSETS: Ratio of total expenses to average net assets................... 0.95% (c) Ratio of net investment income (loss) to average net assets..... (0.82)% (c) Portfolio turnover rate (d)..................................... 0%
(a) Inception date is consistent with the commencement of investment operations and is the date the initial creation unit was established. First Trust Portfolios L.P. seeded the Fund on May 9, 2016 in order to provide initial capital required by SEC rules. (b) Total return is calculated assuming an initial investment made at the net asset value at the beginning of the period, reinvestment of all distributions at net asset value during the period, and redemption at net asset value on the last day of the period. The return presented does not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. Total return is calculated for the time period presented and is not annualized for periods of less than a year. (c) Annualized. (d) Portfolio turnover is calculated for the time period presented and is not annualized for periods of less than a year and does not include securities received or delivered from processing creations or redemptions, derivatives and in-kind transactions. Page 12 See Notes to Consolidated Financial Statements -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 1. ORGANIZATION First Trust Exchange-Traded Fund VII (the "Trust") is an open-end management investment company organized as a Massachusetts business trust on November 6, 2012, and is registered with the Securities and Exchange Commission ("SEC") under the Investment Company Act of 1940, as amended (the "1940 Act"). The Trust consists of two funds that are currently offering shares. This report covers the First Trust Alternative Absolute Return Strategy ETF (the "Fund"), a non-diversified series of the Trust, which trades under the ticker FAAR on The Nasdaq Stock Market LLC ("Nasdaq") and commenced operations on May 18, 2016. Unlike conventional mutual funds, the Fund issues and redeems shares on a continuous basis, at net asset value ("NAV"), only in large specified blocks consisting of 50,000 shares called a "Creation Unit." The Fund's Creation Units are generally issued and redeemed for cash or, in certain circumstances, in-kind for securities in which the Fund invests. Except when aggregated in Creation Units, the shares are not redeemable securities of the Fund. The Fund is an actively managed exchange-traded fund. The investment objective of the Fund is to seek to provide investors with long-term total return. Under normal market conditions, the Fund, through a wholly-owned subsidiary of the Fund, FT Cayman Subsidiary III (the "Subsidiary"), organized under the laws of the Cayman Islands, invests in a portfolio of commodity futures contracts ("Commodities Instruments"). The Fund will not invest directly in Commodities Instruments. The Fund seeks to gain exposure to these investments exclusively by investing in the Subsidiary. The Fund's investment in the Subsidiary may not exceed 25% of the Fund's total assets at the end of each fiscal quarter. There can be no assurance that the Fund will achieve its investment objective. The Fund may not be appropriate for all investors. 2. SIGNIFICANT ACCOUNTING POLICIES The Fund is considered an investment company and follows accounting and reporting guidance under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 946, "Financial Services-Investment Companies." The consolidated financial statements include the accounts on a consolidated basis of the Subsidiary. All intercompany accounts and transactions have been eliminated in consolidation. The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of the consolidated financial statements. The preparation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. Actual results could differ from those estimates. A. PORTFOLIO VALUATION The Fund's NAV is determined daily as of the close of regular trading on the New York Stock Exchange ("NYSE"), normally 4:00 p.m. Eastern time, on each day the NYSE is open for trading. The Fund's NAV is calculated by dividing the value of all assets of the Fund (including accrued interest and dividends), less all liabilities (including accrued expenses and dividends declared but unpaid), by the total number of shares outstanding. The Fund's investments are valued daily at market value or, in the absence of market value with respect to any portfolio securities, at fair value. Market value prices represent last sale or official closing prices from a national or foreign exchange (i.e., a regulated market) and are primarily obtained from third-party pricing services. Fair value prices represent any prices not considered market value prices and are either obtained from a third-party pricing service or are determined by the Pricing Committee of the Fund's investment advisor, First Trust Advisors L.P. ("First Trust" or the "Advisor"), in accordance with valuation procedures adopted by the Trust's Board of Trustees, and in accordance with provisions of the 1940 Act. Investments valued by the Advisor's Pricing Committee, if any, are footnoted as such in the footnotes to the Consolidated Portfolio of Investments. The Fund's investments are valued as follows: Exchange-traded futures contracts are valued at the closing price in the market where such contracts are principally traded. If no closing price is available, exchange-traded futures contracts are fair valued at the mean of their most recent bid and asked price, if available, and otherwise at their closing bid price. If the Fund's investments are not able to be priced by their pre-established pricing methods, such investments may be valued by the Trust's Board of Trustees or its delegate, the Advisor's Pricing Committee, at fair value. A variety of factors may be considered in determining the fair value of such investments. Valuing the Fund's holdings using fair value pricing will result in using prices for those holdings that may differ from current market valuations. The Subsidiary's holdings will be valued in the same manner as the Fund's holdings. Page 13 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 The Fund is subject to fair value accounting standards that define fair value, establish the framework for measuring fair value and provide a three-level hierarchy for fair valuation based upon the inputs to the valuation as of the measurement date. The three levels of the fair value hierarchy are as follows: o Level 1 - Level 1 inputs are quoted prices in active markets for identical investments. An active market is a market in which transactions for the investment occur with sufficient frequency and volume to provide pricing information on an ongoing basis. o Level 2 - Level 2 inputs are observable inputs, either directly or indirectly, and include the following: o Quoted prices for similar investments in active markets. o Quoted prices for identical or similar investments in markets that are non-active. A non-active market is a market where there are few transactions for the investment, the prices are not current, or price quotations vary substantially either over time or among market makers, or in which little information is released publicly. o Inputs other than quoted prices that are observable for the investment (for example, interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates). o Inputs that are derived principally from or corroborated by observable market data by correlation or other means. o Level 3 - Level 3 inputs are unobservable inputs. Unobservable inputs may reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the investment. The inputs or methodologies used for valuing investments are not necessarily an indication of the risk associated with investing in those investments. A summary of the inputs used to value the Fund's investments as of December 31, 2016, is included with the Fund's Consolidated Portfolio of Investments. B. FUTURES CONTRACTS The Fund, through the Subsidiary, may purchase and sell exchange-listed commodity contracts. When the Subsidiary purchases a listed futures contract, it agrees to purchase a specified reference asset (e.g., commodity) at a specified future date. When the Subsidiary sells or shorts a listed futures contract, it agrees to sell a specified reference asset (e.g., commodity) at a specified future date. The price at which the purchase and sale will take place is fixed when the Subsidiary enters into the contract. The exchange clearing corporation is the ultimate counterparty for all exchange-listed contracts, so credit risk is limited to the creditworthiness of the exchange's clearing corporation. Margin deposits are posted as collateral with the clearing broker and, in turn, with the exchange clearing corporation. Exchange-listed commodity futures contracts are generally based upon commodities within the six principal commodity groups: energy, industrial metals, agriculture, precious metals, foods and fibers, and livestock. The price of a commodity futures contract will reflect the storage costs of purchasing the physical commodity. These storage costs include the time value of money invested in the physical commodity plus the actual costs of storing the commodity less any benefits from ownership of the physical commodity that are not obtained by the holder of a futures contract (this is sometimes referred to as the "convenience yield"). To the extent that these storage costs change for an underlying commodity while the Subsidiary is in a long position on that commodity, the value of the futures contract may change proportionately. Upon entering into a futures contract, the Subsidiary must deposit funds, called margin, with its custodian in the name of the clearing broker equal to a specified percentage of the current value of the contract. Open futures contracts are marked-to-market daily with the change in value recognized as a component of "Net change in unrealized appreciation (depreciation) on futures" on the Consolidated Statement of Operations. This daily fluctuation in value of the contracts is also known as variation margin and is included as "Variation margin" payable or receivable on the Consolidated Statement of Assets and Liabilities. When the Subsidiary purchases or sells a futures contract, the Subsidiary is required to collateralize its position in order to limit the risk associated with the use of leverage and other related risks. To collateralize its position, the Subsidiary segregates assets consisting of cash or liquid securities that, when added to any amounts deposited with a futures commission merchant as margin, are equal to the unrealized depreciation of the futures contract or otherwise collateralize its position in a manner consistent with the 1940 Act or the 1940 Act Rules and SEC interpretations thereunder. As the Subsidiary continues to engage in the described securities trading practices and properly segregates assets, the segregated assets will function as a practical limit on the amount of leverage which the Subsidiary may undertake and on the potential increase in the speculative character of the Subsidiary's outstanding portfolio investments. Additionally, such segregated assets generally ensure the availability of adequate funds to meet the obligations of the Subsidiary arising from such investment activities. C. CASH The Fund holds assets equal to or greater than the full notional exposure of the futures contracts. These assets may consist of cash and other short-term securities to comply with SEC guidance with respect to coverage of futures contracts by registered investment companies. Page 14 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 D. INVESTMENT TRANSACTIONS AND INVESTMENT INCOME Investment transactions are recorded as of the trade date. Realized gains and losses from investment transactions are recorded on the identified cost basis. Interest income, if any, is recorded on the accrual basis. E. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS Dividends from net investment income, if any, are declared and paid quarterly by the Fund. The Fund distributes its net realized capital gains, if any, to shareholders at least annually. Distributions in cash may be reinvested automatically in additional whole shares only if the broker through whom the shares were purchased makes such option available. Such shares will generally be reinvested by the broker based upon the market price of those shares and investors may be subject to customary brokerage commissions charged by the broker. Distributions from net investment income and realized capital gains are determined in accordance with income tax regulations, which may differ from U.S. GAAP. Certain capital accounts in the consolidated financial statements are periodically adjusted for permanent differences in order to reflect their tax character. These permanent differences are primarily due to the varying treatment of income and gain/loss on portfolio securities held by the Fund and have no impact on net assets or NAV per share. Temporary differences, which arise from recognizing certain items of income, expense and gain/loss in different periods for consolidated financial statement and tax purposes, will reverse at some time in the future. The Fund paid no distributions during the tax period ended December 31, 2016. As of December 31, 2016, the components of distributable earnings on a tax basis for the Fund were as follows: Net Undistributed Accumulated Unrealized Ordinary Capital and Appreciation Income Other Gains (Depreciation) --------------- --------------- --------------- $ -- $ (1,962) $ (20,762) F. INCOME TAXES The Fund intends to qualify as a regulated investment company by complying with the requirements under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), which includes distributing substantially all of its net investment income and net realized gains to shareholders. Accordingly, no provision has been made for federal and state income taxes. However, due to the timing and amount of distributions, the Fund may be subject to an excise tax of 4% of the amount by which approximately 98% of the Fund's taxable income exceeds the distributions from such taxable income for the calendar year. The Subsidiary is classified as a controlled foreign corporation under Subchapter N of the Code. Therefore, the Fund is required to increase its taxable income by its share of the Subsidiary's income, whether or not such earnings are distributed by the Subsidiary to the Fund. Net investment losses of the Subsidiary cannot be deducted by the Fund in the current period nor carried forward to offset taxable income in future periods. The Fund intends to utilize provisions of the federal income tax laws, which allow it to carry a realized capital loss forward indefinitely following the year of the loss and offset such loss against any future realized capital gains. The Fund is subject to certain limitations under U.S. tax rules on the use of capital loss carryforwards and net unrealized built-in losses. These limitations apply when there has been a 50% change in ownership. At December 31, 2016, the Fund had no capital loss carryforwards outstanding for federal income tax purposes. The Fund is subject to accounting standards that establish a minimum threshold for recognizing, and a system for measuring, the benefits of a tax position taken or expected to be taken in a tax return. Taxable year ended 2016 remains open to federal and state audit. As of December 31, 2016, management has evaluated the application of these standards to the Fund and has determined that no provision for income tax is required in the Fund's consolidated financial statements for uncertain tax positions. In order to present paid-in capital, accumulated net investment income (loss) and accumulated net realized gain (loss) on futures on the Consolidated Statement of Assets and Liabilities that more closely represent their tax character, certain adjustments have been made to paid-in capital, accumulated net investment income (loss) and accumulated net realized gain (loss) on Page 15 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 futures. These adjustments are primarily due to the difference between book and tax treatment of net investment income from the Subsidiary. The results of operations and net assets were not affected by these adjustments. For the period ended December 31, 2016, the adjustments for the Fund were as follows: Accumulated Accumulated Net Realized Net Investment Gain (Loss) Paid-in Income (Loss) on Futures Capital --------------- --------------- --------------- $ (17,456) $ 117,437 $ (99,981) G. EXPENSES Expenses, other than the investment advisory fee and other excluded expenses, are paid by First Trust (see Note 3). H. NEW AND AMENDED FINANCIAL REPORTING RULES AND FORMS On October 13, 2016, the SEC adopted new rules and forms, and amended existing rules and forms. The new and amended rules and forms are intended to modernize the reporting of information provided by funds and to improve the quality and type of information that funds provide to the SEC and investors. The new and amended rules and forms will be effective for the First Trust funds, including the Fund, for reporting periods beginning on and after June 1, 2018. Management is evaluating the new and amended rules and forms to determine the impact to the Fund. I. NEW ACCOUNTING PRONOUNCEMENT In December 2016, FASB released Accounting Standards Update ("ASU") 2016-19 that makes technical changes to various sections of the ASC, including Topic 820, Fair Value Measurement. The changes to Topic 820 are intended to clarify the difference between a valuation approach and a valuation technique. The changes to ASC 820-10-50-2 require a reporting entity to disclose, for Level 2 and Level 3 fair value measurements, a change in either or both a valuation approach and a valuation technique and the reason(s) for the change. The changes to Topic 820 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. At this time, management is evaluating the implications of the ASU and has not yet determined its impact on the consolidated financial statements and disclosures. 3. INVESTMENT ADVISORY FEE, AFFILIATED TRANSACTIONS AND OTHER FEE ARRANGEMENTS First Trust, the investment advisor to the Fund, is a limited partnership with one limited partner, Grace Partners of DuPage L.P., and one general partner, The Charger Corporation. The Charger Corporation is an Illinois corporation controlled by James A. Bowen, Chief Executive Officer of First Trust. First Trust is responsible for the selection and ongoing monitoring of the investments in the Fund's and the Subsidiary's portfolios, managing the Fund's business affairs and providing certain administrative services necessary for the management of the Fund. Pursuant to the Investment Management Agreement between the Trust and the Advisor, First Trust manages the investment of the Fund's assets and is responsible for the Fund's expenses, including the cost of transfer agency, custody, fund administration, legal, audit and other services, but excluding fee payments under the Investment Management Agreement, interest, taxes, brokerage commissions and other expenses connected with the execution of portfolio transactions, distribution and service fees pursuant to a 12b-1 plan, if any, and extraordinary expenses. The Fund has agreed to pay First Trust an annual unitary management fee equal to 0.95% of its average daily net assets. First Trust also provides fund reporting services to the Fund for a flat annual fee in the amount of $9,250, which is covered under the annual unitary management fee. The Subsidiary does not pay First Trust a separate management fee. The Trust has multiple service agreements with Brown Brothers Harriman & Co. ("BBH"). Under the service agreements, BBH performs custodial, fund accounting, certain administrative services, and transfer agency services for the Fund. As custodian, BBH is responsible for custody of the Fund's assets. As fund accountant and administrator, BBH is responsible for maintaining the books and records of the Fund's investments and cash. As transfer agent, BBH is responsible for maintaining shareholder records for the Fund. Each Trustee who is not an officer or employee of First Trust, any sub-advisor or any of their affiliates ("Independent Trustees") is paid a fixed annual retainer that is allocated equally among each fund in the First Trust Fund Complex. Each Independent Trustee is also paid an annual per fund fee that varies based on whether the fund is a closed-end or other actively managed fund, or is an index fund. Page 16 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 Additionally, the Lead Independent Trustee and the Chairmen of the Audit Committee, Nominating and Governance Committee and Valuation Committee are paid annual fees to serve in such capacities, with such compensation allocated pro rata among each fund in the First Trust Fund Complex based on net assets. Independent Trustees are reimbursed for travel and out-of-pocket expenses in connection with all meetings. The Lead Independent Trustee and Committee Chairmen rotate every three years. The officers and "Interested" Trustee receive no compensation from the Trust for acting in such capacities. 4. PURCHASES AND SALES OF INVESTMENTS For the period ended December 31, 2016, the cost of purchases and proceeds from sales of investment securities, excluding short-term investments, derivatives and in-kind transactions, were $0 and $0, respectively. For the period ended December 31, 2016, the Fund did not have any in-kind purchases or sales. 5. DERIVATIVE TRANSACTIONS The following table presents the types of derivatives held by the Subsidiary at December 31, 2016, the primary underlying risk exposure and the location of these instruments as presented on the Consolidated Statement of Assets and Liabilities.
ASSET DERIVATIVES LIABILITY DERIVATIVES -------------------------------------------- -------------------------------------------- CONSOLIDATED CONSOLIDATED DERIVATIVES STATEMENT OF ASSETS AND STATEMENT OF ASSETS AND INSTRUMENT RISK EXPOSURE LIABILITIES LOCATION VALUE LIABILITIES LOCATION VALUE -------------- ---------------- ------------------------------ ----------- ------------------------------ ----------- Futures Commodity Risk Variation Margin Receivable $ 34,426 Variation Margin Payable $ 57,150
The following table presents the amount of net realized gain (loss) and change in net unrealized appreciation (depreciation) recognized for the period ended December 31, 2016, on derivative instruments, as well as the primary underlying risk exposure associated with each instrument. CONSOLIDATED STATEMENT OF OPERATIONS LOCATION ----------------------------------------------------------------------------- COMMODITY RISK EXPOSURE Net realized gain (loss) on futures $ (117,437) Net change in unrealized appreciation (depreciation) on futures (22,724) During the period ended December 31, 2016, the notional values of futures contracts opened and closed were $15,281,231 and $13,018,210 respectively. The Fund does not have the right to offset financial assets and financial liabilities related to futures contracts on the Consolidated Statement of Assets and Liabilities. 6. CREATIONS, REDEMPTIONS AND TRANSACTION FEES Shares are created and redeemed by the Fund only in Creation Unit size aggregations of 50,000 shares in transactions with broker-dealers or large institutional investors that have entered into a participation agreement (an "Authorized Participant"). In order to purchase Creation Units of the Fund, an Authorized Participant must deposit (i) a designated portfolio of securities determined by First Trust (the "Deposit Securities") and generally make or receive a cash payment referred to as the "Cash Component," which is an amount equal to the difference between the NAV of the Fund Shares (per Creation Unit Aggregation) and the market value of the Deposit Securities, and/or (ii) cash in lieu of all or a portion of the Deposit Securities. If the Cash Component is a positive number (i.e., the NAV per Creation Unit Aggregation exceeds the Deposit Amount), the Authorized Participant will deliver the Cash Component. If the Cash Component is a negative number (i.e., the NAV per Creation Unit Aggregation is less than the Deposit Amount), the Authorized Participant will receive the Cash Component. Authorized Participants purchasing Creation Units must pay to BBH, as transfer agent, a creation transaction fee (the "Creation Transaction Fee") regardless of the number of Creation Units purchased in the transaction. The Creation Transaction Fee is based on the composition of the securities included in the Fund's portfolio and the countries in which the transactions are settled. The Creation Transaction Fee is currently $500. The price for each Creation Unit will equal the daily NAV per share times the number of shares in a Creation Unit plus the fees described above and, if applicable, any operational processing and brokerage costs, transfer fees or stamp taxes. When the Fund permits an Authorized Participant to substitute cash or a different security in lieu of depositing one or more of the requisite Deposit Securities, the Authorized Participant may also be assessed an amount to cover the cost of purchasing the Deposit Securities and/or disposing of the substituted securities, including operational processing and brokerage costs, transfer fees, stamp taxes, and part or all of the spread between the expected bid and offer side of the market related to such Deposit Securities and/or substitute securities. Page 17 -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 Authorized Participants redeeming Creation Units must pay to BBH, as transfer agent, a redemption transaction fee (the "Redemption Transaction Fee"), regardless of the number of Creation Units redeemed in the transaction. The Redemption Transaction Fee may vary and is based on the composition of the securities included in the Fund's portfolio and the countries in which the transactions are settled. The Redemption Transaction Fee is currently $500. The Fund reserves the right to effect redemptions in cash. An Authorized Participant may request cash redemption in lieu of securities; however, the Fund may, in its discretion, reject any such request. 7. DISTRIBUTION PLAN The Board of Trustees adopted a Distribution and Service Plan pursuant to Rule 12b-1 under the 1940 Act. In accordance with the Rule 12b-1 plan, the Fund is authorized to pay an amount up to 0.25% of its average daily net assets each year to reimburse First Trust Portfolios L.P. ("FTP"), the distributor of the Fund, for amounts expended to finance activities primarily intended to result in the sale of Creation Units or the provision of investor services. FTP may also use this amount to compensate securities dealers or other persons that are Authorized Participants for providing distribution assistance, including broker-dealer and shareholder support and educational and promotional services. No 12b-1 fees are currently paid by the Fund, and pursuant to a contractual arrangement, no 12b-1 fees will be paid any time before April 12, 2018. 8. INDEMNIFICATION The Trust, on behalf of the Fund, has a variety of indemnification obligations under contracts with its service providers. The Trust's maximum exposure under these arrangements is unknown. However, the Trust has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. 9. SUBSEQUENT EVENTS Management has evaluated the impact of all subsequent events to the Fund through the date the consolidated financial statements were issued, and has determined that there was the following subsequent event: Effective January 3, 2017, the Chicago Mercantile Exchange ("CME") and LCH.Clearnet Limited ("LCH") amended their respective rulebooks to legally characterize variation margin payments -- for derivative contracts that are referred to as settled-to-market (STM) -- as settlements of the derivative's mark-to-market exposure and not collateral. These rulebook changes affect the entities that have derivatives cleared through the CME or LCH. Management is currently evaluating the impact, if any, of these rulebook changes to the Fund's consolidated financial statements and related disclosures. Page 18 -------------------------------------------------------------------------------- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM -------------------------------------------------------------------------------- TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST EXCHANGE-TRADED FUND VII: We have audited the accompanying consolidated statement of assets and liabilities of First Trust Alternative Absolute Return Strategy ETF and Subsidiary (the "Fund"), a series of the First Trust Exchange-Traded Fund VII, including the consolidated portfolio of investments, as of December 31, 2016, and the related consolidated statements of operations and changes in net assets and the consolidated financial highlights for the period from May 18, 2016 (commencement of operations) through December 31, 2016. These consolidated financial statements and consolidated financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2016 by correspondence with the Fund's custodian and brokers. We believe that our audit provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements and consolidated financial highlights referred to above present fairly, in all material respects, the financial position of First Trust Alternative Absolute Return Strategy ETF and Subsidiary as of December 31, 2016, and the results of its operations, changes in its net assets, and financial highlights for the period from May 18, 2016 (commencement of operations) through December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP Chicago, Illinois February 23, 2017 Page 19 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 (UNAUDITED) PROXY VOTING POLICIES AND PROCEDURES A description of the policies and procedures that the Trust uses to determine how to vote proxies and information on how the Fund voted proxies relating to portfolio investments during the most recent 12-month period ended June 30 is available (1) without charge, upon request, by calling (800) 988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; and (3) on the Securities and Exchange Commission's ("SEC") website located at http://www.sec.gov. PORTFOLIO HOLDINGS The Trust files its complete schedule of the Fund's portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. The Trust's Form N-Qs are available (1) by calling (800) 988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3) on the SEC's website at http://www.sec.gov; and (4) for review and copying at the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding the operation of the PRR may be obtained by calling (800) SEC-0330. TAX INFORMATION The Fund made no ordinary income (including short-term capital gain) distributions during the period ended December 31, 2016. Therefore, there was no corporate dividends received deduction available to corporate shareholders and no qualified dividend income. RISK CONSIDERATIONS Risks are inherent in all investing. You should consider the Fund's investment objective, risks, charges and expenses carefully before investing. You can download the Fund's prospectus at http://www.ftportfolios.com or contact First Trust Portfolios L.P. at (800) 621-1675 to request a prospectus, which contains this and other information about the Fund. For additional information about the risks associated with investing in the Fund, please see the Fund's statement of additional information, as well as other regulatory filings. Read these documents carefully before you invest. First Trust Portfolios L.P. is the distributor of First Trust Exchange-Traded Fund VII. The following summarizes some of the risks that should be considered for the Fund. CASH TRANSACTION RISK. The Fund will, under most circumstances, effect a significant portion of creations and redemptions for cash, rather than in-kind securities. As a result, an investment in the Fund may be less tax-efficient than an investment in an exchange-traded fund that effects its creations and redemption for in-kind securities. Because the Fund may effect a portion of redemptions for cash, it may be required to sell portfolio securities in order to obtain the cash needed to distribute redemption proceeds. A sale of shares may result in capital gains or losses and may also result in higher brokerage costs. CLEARING BROKER RISK. The failure or bankruptcy of the Fund's and the Subsidiary's clearing broker could result in a substantial loss of Fund assets. Under current Commodity Futures Trading Commission ("CFTC") regulations, a clearing broker maintains customers' assets in a bulk segregated account. If a clearing broker fails to do so, or is unable to satisfy a substantial deficit in a customer account, its other customers may be subject to risk of loss of their funds in the event of that clearing broker's bankruptcy. In that event, the clearing broker's customers, such as the Fund and the Subsidiary, are entitled to recover, even in respect of property specifically traceable to them, only a proportional share of all property available for distribution to all of that clearing broker's customers. COMMODITY RISK. The value of Commodity Futures typically is based upon the price movements of a physical commodity or an economic variable linked to such price movements. The prices of Commodity Futures may fluctuate quickly and dramatically and may not correlate to price movements in other asset classes. An active trading market may not exist for certain commodities. Each of these factors and events could have a significant negative impact on the Fund. CREDIT RISK. Credit risk is the risk that an issuer of a security will be unable or unwilling to make dividend, interest and/or principal payments when due and the related risk that the value of a security may decline because of concerns about the issuer's ability to make such payments. FOREIGN COMMODITY MARKETS RISK. Trading on commodity markets outside the United States is not regulated by any United States government agency and may involve certain risks not applicable to trading on United States exchanges. The Fund may not have the same access to certain trades as do various other participants in foreign markets. Furthermore, as the Fund determines its net assets in United States dollars, with respect to trading in foreign markets the Fund is subject to the risk of fluctuations in the exchange rate between the local currency and dollars as well as the possibility of exchange controls. Certain futures contracts traded on foreign exchanges are treated differently for federal income tax purposes than are domestic contracts. Page 20 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 (UNAUDITED) FREQUENT TRADING RISK. The frequent trading of futures contracts may increase the amount of commissions or mark-ups to broker-dealers that the Fund pays when it buys and sells contracts, which may detract from the Fund's performance. FUTURES RISK. The Fund invests in futures through the Subsidiary. All futures and futures-related products are highly volatile. Price movements are influenced by, among other things, changing supply and demand relationships; climate; government agricultural, trade, fiscal, monetary and exchange control programs and policies; national and international political and economic events; crop diseases; the purchasing and marketing programs of different nations; and changes in interest rates. In addition, governments from time to time intervene, directly and by regulation, in certain markets, particularly those in currencies. GAP RISK. The Fund is subject to the risk that a commodity price will change from one level to another with no trading in between. Usually such movements occur when there are adverse news announcements, which can cause a commodity price to drop substantially from the previous day's closing price. INCOME RISK. Income from the Fund's fixed income investments could decline during periods of falling interest rates. INTEREST RATE RISK. Interest rate risk is the risk that the value of the debt securities in the Fund's portfolio will decline because of rising market interest rates. Interest rate risk is generally lower for shorter term debt securities and higher for longer term debt securities. Duration is a measure of the expected price volatility of a debt security as a result of changes in market rates of interest, based on, among other factors, the weighted average timing of the debt security's expected principal and interest payments. In general, duration represents the expected percentage change in the value of a security for an immediate 1% change in interest rates. Therefore, prices of debt securities with shorter durations tend to be less sensitive to interest rate changes than debt securities with longer durations. As the value of a debt security changes over time, so will its duration. LIQUIDITY RISK. The Fund invests in futures contracts, which may be less liquid than other types of investments. The illiquidity of futures contracts could have a negative effect on the Fund's ability to achieve its investment objective and may result in losses to Fund shareholders. MANAGEMENT RISK. The Fund is subject to management risk because it is an actively managed portfolio. In managing the Fund's investment portfolio, the Advisor will apply investment techniques and risk analyses that may not have the desired result. There can be no guarantee that the Fund will meet its investment objective. MARKET RISK. Market risk is the risk that a particular security owned by the Fund or shares of the Fund in general, may fall in value. Securities are subject to market fluctuations caused by such factors as economic, political, regulatory or market developments, changes in interest rates and perceived trends in securities prices. Overall securities values could decline generally or could underperform other investments. NEW FUND RISK. The Fund currently has fewer assets than larger funds, and like other relatively new funds, large inflows and outflows may impact the Fund's market exposure for limited periods of time. This impact may be positive or negative, depending on the direction of market movement during the period affected. Also, during the initial invest-up period, the Fund may depart from its principal investment strategies and invest a larger amount or all of its assets in cash equivalents or it may hold cash. NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the 1940 Act, as amended (the "1940 Act"). As a result, the Fund is only limited as to the percentage of its assets that may be invested in the securities of any one issuer by the diversification requirements imposed by the Internal Revenue Code of 1986, as amended. The Fund may invest a relatively high percentage of its assets in a limited number of issuers. As a result, the Fund may be more susceptible to a single adverse economic or regulatory occurrence affecting one or more of these issuers, experience increased volatility and be highly invested in certain issuers. NON-U.S. INVESTMENT RISK. Transactions on non-U.S. exchanges present risks because they may not be subject to the same degree of regulation as their U.S. counterparts. PORTFOLIO TURNOVER RISK. The Subsidiary's higher portfolio turnover may result in the Fund paying higher levels of transaction costs and generating greater tax liabilities for shareholders. Portfolio turnover risk may cause the Fund's performance to be less than you expect. REGULATORY RISK. The Fund's investment decisions may need to be modified, and commodity contract positions held by the Fund may have to be liquidated at disadvantageous times or prices, to avoid exceeding any applicable position limits established by the CFTC, potentially subjecting the Fund to substantial losses. The regulation of commodity transactions in the United States is a rapidly changing area of law and is subject to ongoing modification by government, self-regulatory and judicial action. The effect of any future regulatory change with respect to any aspect of the Fund is impossible to predict, but could be substantial and adverse to the Fund. Page 21 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 (UNAUDITED) REPURCHASE AGREEMENT RISK. The Fund's investment in repurchase agreements may be subject to market and credit risk with respect to the collateral securing the repurchase agreements. Investments in repurchase agreements also may be subject to the risk that the market value of the underlying obligations may decline prior to the expiration of the repurchase agreement term. SHORT SALES RISK. The Fund may sell Commodity Futures short. A short futures position allows the seller to profit from a decline in the price of the underlying commodity to the extent such decline exceeds the transaction costs of the short position. Conversely, if the price of the underlying futures contract rises because of an increase in the price of the underlying commodity, the Fund will realize a loss on the transaction. The Fund bears the risk of unlimited loss on contracts it sells short, as the price at which the Fund would need to cover a short position could theoretically increase without limit. SUBSIDIARY INVESTMENT RISK. Changes in the laws of the United States and/or the Cayman Islands, under which the Fund and the Subsidiary are organized, respectively, could result in the inability of the Fund to operate as intended and could negatively affect the Fund and its shareholders. The Subsidiary is not registered under the 1940 Act and is not subject to all the investor protections of the 1940 Act. Thus, the Fund, as an investor in the Subsidiary, will not have all the protections offered to investors in registered investment companies. TAX RISK. The Fund intends to treat any income it may derive from Commodity Futures (other than derivatives described in Revenue Rulings 20061 and 200631) received by the Subsidiary as "qualifying income" under the provisions of the Internal Revenue Code of 1986, as amended, applicable to "regulated investment companies" ("RICs"), based on a tax opinion received from special counsel which was based, in part, on numerous private letter rulings ("PLRs") provided to third parties not associated with the Fund or its affiliates (which only those parties may rely on as precedent). Shareholders and potential investors should be aware, however, that in September 2016 the Internal Revenue Service released proposed Regulations that, if finalized in the form proposed, would limit the qualifying income from the Subsidiary to the income distributed in the same year in which the income is required to be included in the income of the Fund under the controlled foreign corporation rules. The Fund intends to distribute the income in the same year as the income is required to be included, but a failure to do so could cause the Fund to have non-qualifying income and potentially lose RIC status. If the Fund did not qualify as a RIC for any taxable year and certain relief provisions were not available, the Fund's taxable income would be subject to tax at the Fund level and to a further tax at the shareholder level when such income is distributed. In such event, in order to re-qualify for taxation as a RIC, the Fund might be required to recognize unrealized gains, pay substantial taxes and interest and make certain distributions. This would cause investors to incur higher tax liabilities than they otherwise would have incurred and would have a negative impact on Fund returns. In such event, the Fund's Board of Trustees may determine to reorganize or close the Fund or materially change the Fund's investment objective and strategies. In the event that the Fund fails to qualify as a RIC, the Fund will promptly notify shareholders of the implications of that failure. The Fund may invest a portion of its assets in equity repurchase agreements. Recent changes in the law have the potential of changing the character and source of such instruments potentially subjecting them to unexpected U.S. taxation. Depending upon the terms of the contracts, the Fund may be required to indemnify the counterparty for such increased tax. U.S. GOVERNMENT AND AGENCY SECURITIES RISK. The Fund may invest in U.S. government obligations. U.S. government obligations include U.S. Treasury obligations and securities issued or guaranteed by various agencies of the U.S. government or by various instrumentalities, which have been established or sponsored by the U.S. government. U.S. Treasury obligations are backed by the "full faith and credit" of the U.S. government. Securities issued or guaranteed by federal agencies and U.S. government sponsored instrumentalities may or may not be backed by the full faith and credit of the U.S. government. VOLATILITY RISK. Frequent or significant short-term price movements could adversely impact the performance of the Fund. In addition, the net asset value of the Fund over short-term periods may be more volatile than other investment options because of the Fund's significant use of financial instruments that have a leveraging effect. For example, because of the low margin deposits required, futures trading involves an extremely high degree of leverage and as a result, a relatively small price movement in a Commodities Futures may result in immediate and substantial losses to the Fund. WHIPSAW MARKETS RISK. The Fund may be subject to the forces of "whipsaw" markets (as opposed to choppy or stable markets), in which significant price movements develop but then repeatedly reverse. Such market conditions could cause substantial losses to the Fund. Page 22 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 (UNAUDITED) ADVISORY AGREEMENTS BOARD CONSIDERATIONS REGARDING APPROVAL OF INVESTMENT MANAGEMENT AGREEMENT The Board of Trustees of the First Trust Exchange-Traded Fund VII (the "Trust"), including the Independent Trustees, unanimously approved the Investment Management Agreement (the "Fund Agreement") with First Trust Advisors L.P. ("First Trust") on behalf of First Trust Alternative Absolute Return Strategy ETF (the "Fund"), a series of the Trust, for an initial two-year term at a meeting held on March 6-7, 2016. Because the Fund will seek to achieve its investment objective by investing in commodity futures contracts through a wholly-owned subsidiary of the Fund, the Board of Trustees, including the Independent Trustees, also approved an Investment Management Agreement (the "Subsidiary Agreement" and together with the Fund Agreement, the "Agreements") with First Trust for the wholly-owned subsidiary (the "Subsidiary"), also for an initial two-year term. The Board of Trustees determined that the Agreements are in the best interests of the Fund in light of the extent and quality of services expected to be provided and such other matters as the Board considered to be relevant in the exercise of its reasonable business judgment. To reach this determination, the Board considered its duties under the Investment Company Act of 1940, as amended (the "1940 Act"), as well as under the general principles of state law in reviewing and approving advisory contracts; the requirements of the 1940 Act in such matters; the fiduciary duty of investment advisors with respect to advisory agreements and compensation; the standards used by courts in determining whether investment company boards have fulfilled their duties; and the factors to be considered by the Board in voting on such agreements. To assist the Board in its evaluation of the Agreements, the Independent Trustees received a report from First Trust in advance of the Board meeting responding to a request for information provided on behalf of the Independent Trustees that, among other things, outlined the services to be provided by First Trust to the Fund and the Subsidiary (including the relevant personnel responsible for these services and their experience); the proposed unitary fee structure for the Fund as compared to fees charged by investment advisors to other comparable exchange-traded funds ("ETFs") and as compared to fees charged to other ETFs managed by First Trust; the estimated expenses to be incurred in providing services to the Fund and the potential for economies of scale, if any; financial data on First Trust; any fall out benefits to First Trust and its affiliate, First Trust Portfolios L.P. ("FTP"); and a summary of First Trust's compliance program. The Independent Trustees also met separately with their independent legal counsel to discuss the information provided by First Trust. The Board applied its business judgment to determine whether the arrangements between the Trust and First Trust and between the Subsidiary and First Trust are reasonable business arrangements from the Fund's and the Subsidiary's perspectives as well as from the perspective of shareholders. In evaluating whether to approve the Agreements, the Board considered the nature, extent and quality of services to be provided by First Trust under the Agreements and considered that First Trust employees provide management services to other ETFs and to other investment companies in the First Trust fund complex with diligence and care. The Board considered that the Fund is not designed to track the performance of an index, and investment decisions will be the primary responsibility of First Trust. At the meeting, the Trustees received a presentation from two of the proposed portfolio managers for the Fund and were able to ask questions about the proposed investment strategies for the Fund, including the investment in commodities-related derivatives through the Subsidiary. The Board also considered the compliance program that had been developed by First Trust and the skills of its employees who would be working with the Fund and the Subsidiary. The Board also considered the efforts expended by First Trust in organizing the Trust and in arranging for other entities to provide services to the Fund. Since the Fund had yet to commence investment operations, the Board could not consider the historical investment performance of the Fund. In light of the information presented and the considerations made, the Board concluded that the nature, extent and quality of services to be provided to the Fund and the Subsidiary by First Trust under the Agreements are expected to be satisfactory. The Board reviewed information regarding the proposed unitary fee structure for the Fund. The Board noted that under the Fund's unitary fee arrangement, the Fund would pay First Trust pursuant to the terms of the Fund Agreement a fee equal to an annual rate of 0.95% of its average daily net assets and that First Trust would be responsible for the Fund's ordinary operating expenses, including the cost of transfer agency, custody, fund administration, legal, audit and other services and license fees, if any, but excluding the fee payments under the Fund Agreement, interest, taxes, brokerage commissions, acquired fund fees and expenses, if any, and other expenses connected with the execution of portfolio transactions (such as dividend and distribution expenses from securities sold short and/or other investment related costs), distribution and service fees payable pursuant to a Rule 12b-1 plan, if any, and extraordinary expenses. The Board noted that First Trust would receive no compensation under the Subsidiary Agreement. The Board reviewed information provided by Management Practice Inc. ("MPI"), an independent source, for the Fund on the advisory fees and expense ratios of other comparable ETFs. The Board noted that the Fund's expense ratio under its proposed unitary fee was equal to the median net expense ratio of the MPI peer group. The Board also considered information provided by First Trust on the advisory fees and expense ratios of all other actively-managed ETFs in the market. The Board considered the total expense ratios (after fee waivers and/or expense reimbursements, if applicable) of other First Trust ETFs, including First Trust ETFs that pay a unitary fee and First Trust ETFs that are actively managed, noting that First Trust provides advisory services to another actively-managed ETF that seeks to provide investors with commodity exposure by investing in commodity futures contracts and Page 23 -------------------------------------------------------------------------------- ADDITIONAL INFORMATION (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 (UNAUDITED) exchange-traded commodity linked instruments through a wholly-owned subsidiary of the fund and that pays a unitary fee at the same rate as the unitary fee proposed for the Fund. In light of the information considered and the nature, extent and quality of services expected to be provided under the Agreements, the Board determined that the proposed unitary fee for the Fund was fair and reasonable. The Board noted that the proposed unitary fee for the Fund was not structured to pass the benefits of any economies of scale on to shareholders as the Fund's assets grow. The Board noted that any reduction in fixed costs associated with the management of the Fund would benefit First Trust, but that a unitary fee structure provides a level of certainty in expenses for the Fund. The Board noted that First Trust has continued to invest in personnel and infrastructure for the First Trust fund complex. The Board took the costs to be borne by First Trust in connection with its services to be performed for the Fund under the Fund Agreement into consideration and noted that First Trust was unable to estimate the profitability of the Fund Agreement to First Trust. The Board considered fall-out benefits described by First Trust that may be realized from its and FTP's relationship with the Fund and First Trust's compensation for fund reporting services pursuant to a separate Fund Reporting Services Agreement, which would be included under the unitary fee. The Board also noted that First Trust would not utilize soft dollars in connection with its management of the Fund's portfolio. Based on all of the information considered and the conclusions reached, the Board, including the Independent Trustees, unanimously determined that the terms of the Agreements are fair and reasonable and that the approval of the Agreements is in the best interests of the Fund. No single factor was determinative in the Board's analysis. Page 24 -------------------------------------------------------------------------------- BOARD OF TRUSTEES AND OFFICERS -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 (UNAUDITED) The Trust's respective statement of additional information includes additional information about the Trustees and is available, without charge, upon request, by calling (800) 988-5891.
NUMBER OF OTHER PORTFOLIOS IN TRUSTEESHIPS OR TERM OF OFFICE THE FIRST TRUST DIRECTORSHIPS NAME, ADDRESS, AND YEAR FIRST FUND COMPLEX HELD BY TRUSTEE DATE OF BIRTH AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING PAST POSITION WITH THE TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS ------------------------------------------------------------------------------------------------------------------------------------ INDEPENDENT TRUSTEES ------------------------------------------------------------------------------------------------------------------------------------ Richard E. Erickson, Trustee o Indefinite Term Physician, Officer, Wheaton Orthopedics; 138 None c/o First Trust Advisors L.P. Limited Partner, Gundersen Real Estate 120 E. Liberty Drive, o Since Inception Limited Partnership (June 1992 to Suite 400 December 2016); Member, Sportsmed Wheaton, IL 60187 LLC (April 2007 to November 2015) D.O.B.: 04/51 Thomas R. Kadlec, Trustee o Indefinite Term President, ADM Investor Services, Inc. 138 Director of ADM c/o First Trust Advisors L.P. (Futures Commission Merchant) Investor Services, 120 E. Liberty Drive, o Since Inception Inc., ADM Suite 400 Investor Services Wheaton, IL 60187 International and D.O.B.: 11/57 Futures Industry Association Robert F. Keith, Trustee o Indefinite Term President, Hibs Enterprises (Financial 138 Director of Trust c/o First Trust Advisors L.P. and Management Consulting) Company of 120 E. Liberty Drive, o Since Inception Illinois Suite 400 Wheaton, IL 60187 D.O.B.: 11/56 Niel B. Nielson, Trustee o Indefinite Term Managing Director and Chief Operating 138 Director of c/o First Trust Advisors L.P. Officer (January 2015 to Present), Covenant 120 E. Liberty Drive, o Since Inception Pelita Harapan Educational Foundation Transport, Inc. Suite 400 (Educational Products and Services); (May 2003 to Wheaton, IL 60187 President and Chief Executive Officer May 2014) D.O.B.: 03/54 (June 2012 to September 2014), Servant Interactive LLC (Educational Products and Services); President and Chief Executive Officer (June 2012 to September 2014), Dew Learning LLC (Educational Products and Services); President (June 2002 to June 2012), Covenant College ------------------------------------------------------------------------------------------------------------------------------------ INTERESTED TRUSTEE ------------------------------------------------------------------------------------------------------------------------------------ James A. Bowen(1), Trustee o Indefinite Term Chief Executive Officer, First Trust 138 None and Chairman of the Board Advisors L.P. and First Trust Portfolios 120 E. Liberty Drive, o Since Inception L.P.; Chairman of the Board of Directors, Suite 400 BondWave LLC (Software Development Wheaton, IL 60187 Company) and Stonebridge Advisors LLC D.O.B.: 09/55 (Investment Advisor)
----------------------------- (1) Mr. Bowen is deemed an "interested person" of the Trust due to his position as Chief Executive Officer of First Trust Advisors L.P., investment advisor of the Trust. Page 25 -------------------------------------------------------------------------------- BOARD OF TRUSTEES AND OFFICERS (CONTINUED) -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 (UNAUDITED)
POSITION AND TERM OF OFFICE NAME, ADDRESS OFFICES AND LENGTH OF PRINCIPAL OCCUPATIONS AND DATE OF BIRTH WITH TRUST SERVICE DURING PAST 5 YEARS ------------------------------------------------------------------------------------------------------------------------------------ OFFICERS(2) ------------------------------------------------------------------------------------------------------------------------------------ James M. Dykas President and Chief o Indefinite Term Managing Director and Chief Financial Officer 120 E. Liberty Drive, Executive Officer (January 2016 to Present), Controller (January 2011 Suite 400 o Since January 2016 to January 2016), Senior Vice President (April 2007 Wheaton, IL 60187 to January 2016), First Trust Advisors L.P. and First D.O.B.: 01/66 Trust Portfolios L.P.; Chief Financial Officer (January 2016 to Present), BondWave LLC (Software Development Company) and Stonebridge Advisors LLC (Investment Advisor) Donald P. Swade Treasurer, Chief Financial o Indefinite Term Senior Vice President (July 2016 to Present), Vice 120 E. Liberty Drive, Officer and Chief President (April 2012 to July 2016), First Trust Suite 400 Accounting Officer o Since January 2016 Advisors L.P. and First Trust Portfolios L.P.; Vice Wheaton, IL 60187 President (September 2006 to April 2012), D.O.B.: 08/72 Guggenheim Funds Investment Advisors, LLC and Claymore Securities, Inc. W. Scott Jardine Secretary and Chief o Indefinite Term General Counsel, First Trust Advisors L.P. and First 120 E. Liberty Drive, Legal Officer Trust Portfolios L.P.; Secretary and General Suite 400 o Since Inception Counsel, BondWave LLC, Secretary, Stonebridge Wheaton, IL 60187 Advisors LLC D.O.B.: 05/60 Daniel J. Lindquist Vice President o Indefinite Term Managing Director (July 2012 to Present), Senior 120 E. Liberty Drive, Vice President (September 2005 to July 2012), First Suite 400 o Since Inception Trust Advisors L.P. and First Trust Portfolios L.P. Wheaton, IL 60187 D.O.B: 02/70 Kristi A. Maher Chief Compliance Officer o Indefinite Term Deputy General Counsel, First Trust Advisors L.P. 120 E. Liberty Drive, and Assistant Secretary and First Trust Portfolios L.P. Suite 400 o Since Inception Wheaton, IL 60187 D.O.B.: 12/66 Roger F. Testin Vice President o Indefinite Term Senior Vice President (November 2003 to Present), 120 E. Liberty Drive, First Trust Advisors L.P. and First Trust Portfolios Suite 400 o Since Inception L.P. Wheaton, IL 60187 D.O.B.: 06/66 Stan Ueland Vice President o Indefinite Term Senior Vice President (September 2012 to Present), 120 E. Liberty Drive, Vice President (August 2005 to September 2012), Suite 400 o Since Inception First Trust Advisors L.P. and First Trust Portfolios Wheaton, IL 60187 L.P. D.O.B.: 11/70
----------------------------- (2) The term "officer" means the president, vice president, secretary, treasurer, controller or any other officer who performs a policy making function. Page 26 -------------------------------------------------------------------------------- PRIVACY POLICY -------------------------------------------------------------------------------- FIRST TRUST ALTERNATIVE ABSOLUTE RETURN STRATEGY ETF (FAAR) DECEMBER 31, 2016 (UNAUDITED) PRIVACY POLICY First Trust values our relationship with you and considers your privacy an important priority in maintaining that relationship. We are committed to protecting the security and confidentiality of your personal information. SOURCES OF INFORMATION We collect nonpublic personal information about you from the following sources: o Information we receive from you and your broker-dealer, investment advisor or financial representative through interviews, applications, agreements or other forms; o Information about your transactions with us, our affiliates or others; o Information we receive from your inquiries by mail, e-mail or telephone; and o Information we collect on our website through the use of "cookies". For example, we may identify the pages on our website that your browser requests or visits. INFORMATION COLLECTED The type of data we collect may include your name, address, social security number, age, financial status, assets, income, tax information, retirement and estate plan information, transaction history, account balance, payment history, investment objectives, marital status, family relationships and other personal information. DISCLOSURE OF INFORMATION We do not disclose any nonpublic personal information about our customers or former customers to anyone, except as permitted by law. In addition to using this information to verify your identity (as required under law), the permitted uses may also include the disclosure of such information to unaffiliated companies for the following reasons: o In order to provide you with products and services and to effect transactions that you request or authorize, we may disclose your personal information as described above to unaffiliated financial service providers and other companies that perform administrative or other services on our behalf, such as transfer agents, custodians and trustees, or that assist us in the distribution of investor materials such as trustees, banks, financial representatives, proxy services, solicitors and printers. o We may release information we have about you if you direct us to do so, if we are compelled by law to do so, or in other legally limited circumstances (for example to protect your account from fraud). In addition, in order to alert you to our other financial products and services, we may share your personal information within First Trust. PRIVACY ONLINE We allow third-party companies, including AddThis (a social media sharing service), to collect certain anonymous information when you visit our website. These companies may use non-personally identifiable information during your visits to this and other websites in order to provide advertisements about goods and services likely to be of greater interest to you. These companies typically use a cookie, third party web beacon or pixel tags, to collect this information. To learn more about this behavioral advertising practice, you can visit www.networkadvertising.org. CONFIDENTIALITY AND SECURITY With regard to our internal security procedures, First Trust restricts access to your nonpublic personal information to those First Trust employees who need to know that information to provide products or services to you. We maintain physical, electronic and procedural safeguards to protect your nonpublic personal information. POLICY UPDATES AND INQUIRIES As required by federal law, we will notify you of our privacy policy annually. We reserve the right to modify this policy at any time, however, if we do change it, we will tell you promptly. For questions about our policy, or for additional copies of this notice, please go to www.ftportfolios.com, or contact us at 1-800-621-1675 (First Trust Portfolios) or 1-800-222-6822 (First Trust Advisors). March 2016 Page 27 This page intentionally left blank. FIRST TRUST First Trust Exchange-Traded Fund VII INVESTMENT ADVISOR First Trust Advisors L.P. 120 E. Liberty Drive, Suite 400 Wheaton, IL 60187 ADMINISTRATOR, CUSTODIAN FUND ACCOUNTANT & TRANSFER AGENT Brown Brothers Harriman & Co. 50 Post Office Square Boston, MA 02110 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP 111 S. Wacker Drive Chicago, IL 60606 LEGAL COUNSEL Chapman and Cutler LLP 111 W. Monroe Street Chicago, IL 60603 [BLANK BACK COVER] ITEM 2. CODE OF ETHICS. (a) The registrant, as of the end of the period covered by this report, has adopted a code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party. (c) There have been no amendments, during the period covered by this report, to a provision of the code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party, and that relates to any element of the code of ethics description. (d) The registrant, during the period of this report, has not granted any waivers, including an implicit waiver, from a provision of the code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party, that relates to one or more of the items set forth in paragraph (b) of this item's instructions. (e) Not applicable. ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. As of the end of the period covered by the report, the registrant's board of trustees has determined that Thomas R. Kadlec and Robert F. Keith are qualified to serve as audit committee financial experts serving on its audit committee and that each of them is "independent," as defined by Item 3 of Form N-CSR. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. (a) Audit Fees (Registrant) -- The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements were $30,000 for the fiscal year ended December 31, 2015 and $56,000 for fiscal year ended December 31, 2016. (b) Audit-Related Fees (Registrant) -- The aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of this Item were $0 for the fiscal year ended December 31, 2015, and $183.82 for the fiscal year ended December 31, 2016. Audit-Related Fees (Investment Adviser and Distributor) -- The aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of this Item were $0 for the fiscal year ended December 31, 2015, and $0 for the fiscal year ended December 31, 2016. (c) Tax Fees (Registrant) -- The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning to the registrant were $6,000 for the fiscal year ended December 31, 2015 and $6,000 for fiscal year ended December 31, 2016. Tax Fees (Investment Adviser and Distributor) -- The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning to the registrant's adviser and distributor were $0 for the fiscal year ended December 31, 2015, and $0 for the fiscal year ended December 31, 2016. (d) All Other Fees (Registrant) -- The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant to the registrant, other than the services reported in paragraphs (a) through (c) of this Item were $0 for the fiscal year ended December 31, 2015, and $0 for the fiscal year ended December 31, 2016. All Other Fees (Investment Adviser and Distributor) -- The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant to the registrant's investment adviser and distributor, other than the services reported in paragraphs (a) through (c) of this Item were $0 for the fiscal year ended December 31, 2015, and $0 for the fiscal year ended December 31, 2016. (e)(1) Disclose the audit committee's pre-approval policies and procedures described in paragraph (c)(7) of Rule 2-01 of Regulation S-X. Pursuant to its charter and its Audit and Non-Audit Services Pre-Approval Policy, the Audit Committee (the "Committee") is responsible for the pre-approval of all audit services and permitted non-audit services (including the fees and terms thereof) to be performed for the registrant by its independent auditors. The Chairman of the Committee is authorized to give such pre-approvals on behalf of the Committee up to $25,000 and report any such pre-approval to the full Committee. The Committee is also responsible for the pre-approval of the independent auditor's engagements for non-audit services with the registrant's adviser (not including a sub-adviser whose role is primarily portfolio management and is sub-contracted or overseen by another investment adviser) and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant, if the engagement relates directly to the operations and financial reporting of the registrant, subject to the de minimis exceptions for non-audit services described in Rule 2-01 of Regulation S-X. If the independent auditor has provided non-audit services to the registrant's adviser (other than any sub-adviser whose role is primarily portfolio management and is sub-contracted with or overseen by another investment adviser) and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to its policies, the Committee will consider whether the provision of such non-audit services is compatible with the auditor's independence. (e)(2) The percentage of services described in each of paragraphs (b) through (d) for the registrant and the registrant's investment adviser of this Item that were approved by the audit committee pursuant to the pre-approval exceptions included in paragraph (c)(7)(i)(c) or paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X are as follows: (b) 0% (c) 0% (d) 0% (f) The percentage of hours expended on the principal accountant's engagement to audit the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees was less than fifty percent. (g) The aggregate non-audit fees billed by the registrant's accountant for services rendered to the registrant, and rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the registrant for fiscal year ended December 31, 2015 were $6,000 for the registrant, $12,500 for the registrant's investment adviser and $29,000 for the registrant's distributor and for the registrant's fiscal year ended December 31, 2016 were $6,000 for the registrant, $13,000 for the registrant's investment adviser and $32,500 for the registrant's distributor. (h) The registrant's audit committee of its Board of Trustees has determined that the provision of non-audit services that were rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with maintaining the principal accountant's independence. ITEMS 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. The registrant has a separately designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934 consisting of all the independent directors of the registrant. The audit committee of the registrant is comprised of: Richard E. Erickson, Thomas R. Kadlec, Robert F. Keith and Niel B. Nielson. ITEM 6. INVESTMENTS. (a) Schedule of Investments in securities of unaffiliated issuers as of the close of the reporting period is included as part of the report to shareholders filed under Item 1 of this form. (b) Not applicable. ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. Not applicable. ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. Not applicable. ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASERS. Not applicable. ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There have been no material changes to the procedures by which the shareholders may recommend nominees to the registrant's board of directors, where those changes were implemented after the registrant last provided disclosure in response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR 229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)), or this Item. ITEM 11. CONTROLS AND PROCEDURES. (a) The registrant's principal executive and principal financial officers, or persons performing similar functions, have concluded that the registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended (the "1940 Act") (17 CFR 270.30a-3 (c))) are effective, as of a date within 90 days of the filing date of the report that includes the disclosure required by this paragraph, based on their evaluation of these controls and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15 (b)). (b) There were no changes in the registrant's internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR 270.30a-3(d)) that occurred during the registrant's last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, the registrant's internal control over financial reporting. ITEM 12. EXHIBITS. (a)(1) Code of ethics, or any amendment thereto, that is the subject of disclosure required by Item 2 is attached hereto. (a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto. (a)(3) Not Applicable (b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. (registrant) First Trust Exchange-Traded Fund VII ---------------------------------------------------- By (Signature and Title)* /s/ James M. Dykas ---------------------------------------- James M. Dykas, President and Chief Executive Officer (principal executive officer) Date: February 23, 2017 ------------------- 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/ James M. Dykas ---------------------------------------- James M. Dykas, President and Chief Executive Officer (principal executive officer) Date: February 23, 2017 ------------------- By (Signature and Title)* /s/ Donald P. Swade ---------------------------------------- Donald P. Swade, Treasurer, Chief Financial Officer and Chief Accounting Officer (principal financial officer) Date: February 23, 2017 ------------------- * Print the name and title of each signing officer under his or her signature.