Fort Dearborn Income Securities, Inc. (NYSE:FDI) (the “Fund”) announced that the Board of Directors of the Fund approved changes to certain investment policies of the Fund, as well as approved and recommended that shareholders approve the amendment and elimination of certain fundamental investment policies and restrictions at the Fund’s upcoming annual meeting. Together, the approved and recommended changes seek to provide additional investment flexibility to more efficiently manage the Fund’s exposures, help maintain the distribution rate at competitive levels relative to the market and make sure that the Fund’s shares remain attractive to both existing and prospective shareholders.
The Board approved the following, effective December 31, 2013: 1) permitting the Fund to purchase non-US dollar-denominated securities; 2) allowing the Fund to invest up to 10% of its assets in collateralized loan obligations; and 3) clarifying that the Fund may invest up to 25% of its total assets in a combination of (a) below investment grade privately placed debt securities; (b) preferred stock; (c) convertible securities or debt issued with warrants to purchase common stock, provided the market value of all warrants does not exceed 2% of the net asset value of the Fund; and (d) below investment grade obligations of foreign governments or foreign corporations.
Each of the changes highlighted above, combined with the changes outlined below, seek to provide the Fund with a broader array of investment choices, presenting the Fund with the opportunity to improve its overall risk-adjusted returns.
In addition, as noted above, the Board approved and recommended that at the annual meeting of shareholders, to be held on December 6, 2013, that shareholders approve changes to the Fund’s investment policies and restrictions, as described below. These changes, if approved, will also become effective on December 31, 2013.
Shareholders will be asked to approve amendments to convert the Fund’s fundamental policy of investing at least 75% of the Fund’s total assets in investment grade debt to a non-fundamental policy. The amended policy will also clarify, modernize and streamline the language used to describe the types of investment grade securities that are permitted to be included in the 75% bucket and seek to provide the Fund with future flexibility to respond to market changes. For example, a number of the Fund’s investment policies are linked to credit ratings, including the Fund’s current policy to invest 75% of the Fund’s total assets in debt obligations that at the time of purchase are rated in the four highest credit rating grades of Moody’s Investor Services, Inc. (“Moody’s”) and Standard & Poor’s Rating Services (“S&P”). The current ratings policies date back to 1993, when the Fund’s prospectus was last updated in conjunction with a rights offering. Since then, Fitch Ratings, Inc. (“Fitch”) has established itself as the third major ratings agency and is viewed by UBS Global Asset Management (Americas), Inc. (“UBS Global AM”), the Fund’s Investment Advisor, as being just as reliable as the other two ratings organizations. The proposed amended 75% policy, noted below, now incorporates Fitch:
The Fund invests at least 75% of its total assets in non-convertible fixed income securities, which at the time of purchase are considered investment grade by being rated in the four highest grades as determined by Moody’s, S&P or Fitch, or if not rated, are considered by the Investment Advisor to be of comparable investment quality. For purposes of this policy, the Fund’s investment in investment grade, non-convertible fixed income securities may include corporate debt securities of US and non-US issuers, securities of the US government, its agencies and government-sponsored enterprises, securities guaranteed by the US government, obligations of non-US governments or their subdivisions, agencies and government-sponsored enterprises, obligations of international agencies or supranational entities, mortgage-backed securities, asset-backed securities, commercial paper and cash or cash equivalents.
As noted earlier, the Fund’s offering documents and respective policies have not been updated in almost two decades and, therefore, feature a number of restrictions that many modern funds no longer employ. As such, shareholders will also be asked to approve amendments to the Fund’s borrowing and senior securities investment restriction and the Fund’s commodities restriction. These changes will provide the Fund with more modern restriction that will no longer prevent the Fund from using derivative instruments, such as futures, forwards, swaps and options, to more efficiently manage the Fund’s investments. Also, amending the borrowing and senior securities restrictions will modernize the language of the restriction and remove any ambiguity with respect to the Fund’s ability to engage in structural leverage (e.g., borrowing from a bank for investment purposes), if it is determined that such leverage would be beneficial at some time in the future. At this time, while we do not intend to engage in structural leverage (such as borrowing from a bank for investment purposes), we will alert the Fund’s shareholders, in writing, should the Board and UBS Global AM decide to implement such strategies in the future.
Finally, shareholders will be asked to approve the elimination of four outdated fundamental investment restrictions that currently prevent the Fund from employing derivative instruments as additional tools to manage the Fund’s exposures and provide greater flexibility in portfolio construction. The investment restrictions that shareholders are being asked to approve for elimination include restrictions prohibiting: 1) mortgaging, hypothecating or pledging assets; 2) purchasing securities on margin; 3) making short sales or maintaining short positions; and 4) engaging in options. UBS Global AM seeks to initiate use of derivative instruments in the Fund to more efficiently manage its exposures. For example, the Fund may utilize interest rate instruments, such as futures, to more precisely manage the Fund’s interest rate exposure, while potentially seeking to improve its earnings potential by investing in longer maturity, higher-yielding debt, but reducing overall portfolio interest rate exposure using futures. Furthermore, the Fund intends to utilize currency instruments (e.g., foreign exchange forwards) to hedge any foreign currency exposure back to the US dollar. Overall, the Fund expects to use derivative instruments for both hedging and investment purposes.
Collectively, the aforementioned changes build on policy adjustments the Fund already implemented in June 2013, which included: 1) changing the Fund’s benchmark from the Investment Grade Bond Index, to the Barclays US Aggregate Index; and 2) adjusting the Fund’s portfolio duration range, from its prior range of ±2 years, to ±3 years, of the benchmark’s duration. While changes implemented in June 2013 sought to reduce the Fund’s interest rate risk sensitivity, these new changes now target to redeploy that risk in other areas of the portfolio, seeking to improve the overall risk-adjusted performance and the Fund’s earnings potential by widening the investable universe, modernizing policies, removing outdated limitations and arming the investment team with tools to more efficiently manage portfolio risks and exposures.
The Board has set Friday, October 11, 2013 as the record date for determination of the shareholders entitled to vote at the Fund’s annual meeting of shareholders, to be held on Friday, December 6, 2013. The matters to be considered at the annual meeting are the election of directors, amending and converting to non-fundamental the Fund's fundamental investment policy, amending certain fundamental restrictions, eliminating certain outdated fundamental investment restrictions, and transacting such other business as may properly come before the meeting.
In connection with the Fund’s annual meeting of shareholders, a proxy statement will be filed with the SEC. WE URGE SHAREHOLDERS TO READ THE PROXY STATEMENT CAREFULLY WHEN IT BECOMES AVAILABLE BECAUSE IT WILL CONTAIN IMPORTANT INFORMATION ABOUT THE FUND. Shareholders will be able to obtain free copies of the proxy statement (when available), as well as other filed documents containing information about the Fund, at www.sec.gov, the SEC’s Internet site. Shareholders can also obtain copies of these documents and other related documents, when available, for free by calling the Fund’s proxy solicitor, Georgeson Inc. at 866-316 3922.
Additional risk considerations
While the changes discussed above present attractive investment opportunities, they may potentially introduce additional risks, which are further outlined below.
Derivatives risk: The value of “derivatives”—so called because their value “derives” from the value of an underlying asset, reference rate or index—may rise or fall more rapidly than other investments. When using derivatives for non-hedging purposes, it is possible for the Fund to lose more than the amount it invested in the derivative. The risks of investing in derivative instruments also include market and management risks. Derivatives relating to fixed income markets are especially susceptible to interest rate risk and credit risk. In addition, many types of swaps and other non-exchange traded derivatives may be subject to liquidity risk, credit risk and mispricing or valuation complexity. These derivatives risks are different from, and may be greater than, the risks associated with investing directly in securities and other instruments.
Leverage risk associated with financial instruments: The use of financial instruments to increase potential returns, including derivatives used for investment (nonhedging) purposes, may cause the Fund to be more volatile than if it had not been leveraged. The use of leverage may also accelerate the velocity of losses and can result in losses to the Fund that exceed the amount originally invested.
Collateralized Loan Obligations (CLOs): A CLO is a trust typically collateralized by a pool of loans, which may include, among others, domestic and foreign senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be rated below investment grade or equivalent unrated loans. CLOs may charge management fees and administrative expenses. In addition to the normal risks associated with debt securities (e.g., interest rate risk, credit risk and default risk), CLOs carry additional risks including, but not limited to: (i) the possibility that distributions will not be adequate to make interest or other payments; (ii) the collateral may decline in value or quality or go into default; (iii) the Fund may invest in tranches of a CLO that are subordinate to other classes; and (iv) the complex structure of the security may not be fully understood at the time of investment and may produce disputes with the issuer, difficulty in valuing the security or unexpected investment results.
Fort Dearborn Income Securities, Inc. is a closed-end bond fund managed by UBS Global AM. The Fund invests principally in investment grade, long-term fixed income debt securities. The primary objective of the Fund is to provide its shareholders with:
Further information regarding the Fund, including a discussion of principal objectives, principal investment strategies and principal risks, may be found in the fund overview located at http://www.ubs.com/closedendfundsinfo. You may also request copies of the fund overview by calling the Closed-End Funds Desk at 888-793 8637.
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