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 811-22039
First Trust Specialty Finance and Financial Opportunities Fund
(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: November 30
Date of reporting period: May 31, 2010
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. Section 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
FIRST TRUST
SPECIALTY FINANCE
AND FINANCIAL
OPPORTUNITIES FUND
SEMI-ANNUAL REPORT
FOR THE SIX MONTHS ENDED
MAY 31, 2010
(FIRST TRUST LOGO)
(CONFLUENCE INVESTMENT MANAGEMENT LOGO)
TABLE OF CONTENTS
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND (FGB)
SEMI-ANNUAL REPORT
MAY 31, 2010
Shareholder Letter ................... 1
At a Glance .......................... 2
Portfolio Commentary ................. 3
Portfolio of Investments ............. 6
Statement of Assets and Liabilities .. 9
Statement of Operations .............. 10
Statements of Changes in Net Assets .. 11
Statement of Cash Flows .............. 12
Financial Highlights ................. 13
Notes to Financial Statements ........ 14
Additional Information ............... 20
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934,
as amended. Forward-looking statements include statements regarding the goals,
beliefs, plans or current expectations of First Trust Advisors L.P. ("First
Trust" or the "Advisor") and/or Confluence Investment Management LLC
("Confluence" or the "Sub-Advisor") and their respective representatives, taking
into account the information currently available to them. Forward-looking
statements include all statements that do not relate solely to current or
historical fact. For example, forward-looking statements include the use of
words such as "anticipate," "estimate," "intend," "expect," "believe," "plan,"
"may," "should," "would" or other words that convey uncertainty of future events
or outcomes.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
First Trust Specialty Finance and Financial Opportunities 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/or Sub-Advisor and their respective representatives only as of the
date hereof. We undertake no obligation to publicly revise or update these
forward-looking statements to reflect events and circumstances that arise after
the date hereof.
PERFORMANCE AND RISK DISCLOSURE
There is no assurance that the Fund will achieve its investment objectives. The
Fund is subject to market risk, which is the possibility that the market values
of securities owned by the Fund will decline and that the value of the Fund
shares may therefore be less than what you paid for them. Accordingly, you can
lose money investing in the Fund. See "Risk Considerations" in the Notes to
Financial Statements 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 common share price will fluctuate and Fund shares,
when sold, may be worth more or less than their original cost.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment. It
includes details about the Fund and presents data and analysis that provide
insight into the Fund's performance and investment approach.
By reading the portfolio commentary by the portfolio management team of the
Fund, you may obtain an understanding of how the market environment affected the
Fund's performance. The statistical information that follows may help you
understand the Fund's performance compared to that of the relevant market
benchmarks.
It is important to keep in mind that the opinions expressed by personnel of
Confluence are just that: informed opinions. They should not be considered to be
promises or advice. The opinions, like the statistics, cover the period through
the date on the cover of this report. The risks of investing in the Fund are
spelled out in the prospectus, the statement of additional information, this
report, and other regulatory filings.
SHAREHOLDER LETTER
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND (FGB)
SEMI-ANNUAL REPORT
MAY 31, 2010
Dear Shareholders:
I am pleased to present you with the semi-annual report for your investment in
First Trust Specialty Finance and Financial Opportunities Fund (the "Fund").
First Trust Advisors L.P. ("First Trust") has always believed that staying
invested in quality products and having a long-term horizon can help investors
reach their financial goals. The past eighteen months have been challenging, but
successful investors understand that the success they have achieved is typically
because of their long-term investment perspective through all kinds of markets.
The report you hold contains detailed information about your investment; a
portfolio commentary from the Fund's management team that provides a recap of
the period; a performance analysis and a market and Fund outlook. Additionally,
you will find the Fund's financial statements for the six month period covered
by this report. I encourage you to read this document and discuss it with your
financial advisor.
First Trust offers a variety of products that can fit many financial plans to
help those investors who are seeking long-term financial success. You may want
to talk to your advisor about the other investments we offer that might fit your
financial plan.
At First Trust we continue to be committed to making available up-to-date
information about your investments so you and your financial advisor have
current information on your portfolio. We value our relationship with you, and
we thank you for the opportunity to assist you in achieving your financial
goals.
Sincerely,
/s/ James A. Bowen
James A. Bowen
President of First Trust
Specialty Finance and
Financial Opportunities Fund
Page 1
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
"AT A GLANCE"
AS OF MAY 31, 2010 (UNAUDITED)
FUND STATISTICS
Symbol on New York Stock Exchange FGB
Common Share Price $ 6.93
Common Share Net Asset Value ("NAV") $ 6.77
Premium (Discount) to NAV 2.36%
Net Assets Applicable to Common Shares $96,325,639
Current Quarterly Distribution per Common Share (1) $ 0.1500
Current Annualized Distribution per Common Share $ 0.6000
Current Distribution Rate on Closing Common Share Price (2) 8.66%
Current Distribution Rate on NAV (2) 8.86%
COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE)
(PERFORMANCE GRAPH)
Market NAV
5/31/2009 4.09 4.42
6/5/2009 4.58 4.73
6/12/2009 4.2 4.69
6/19/2009 4.28 4.74
6/26/2009 4.43 4.82
7/2/2009 4.47 4.8
7/10/2009 3.93 4.53
7/17/2009 4.5 4.93
7/24/2009 4.6 5.21
7/31/2009 4.96 5.51
8/7/2009 5.33 5.84
8/14/2009 5.2 5.58
8/21/2009 5 5.63
8/28/2009 5.14 5.62
9/4/2009 5.08 5.47
9/11/2009 5.23 5.74
9/18/2009 5.49 6.04
9/25/2009 5.43 5.89
10/2/2009 5.29 5.83
10/9/2009 5.59 6.06
10/16/2009 5.42 6.02
10/23/2009 5.46 5.93
10/30/2009 5.2 5.69
11/6/2009 5.36 5.88
11/13/2009 5.5 5.88
11/20/2009 5.32 5.93
11/27/2009 5.44 5.89
12/4/2009 5.64 6.15
12/11/2009 5.58 6.2
12/18/2009 5.74 6.26
12/24/2009 5.98 6.48
12/31/2009 5.98 6.42
1/8/2010 6.4 6.74
1/15/2010 6.33 6.74
1/22/2010 6.12 6.59
1/29/2010 5.86 6.45
2/5/2010 5.63 6.34
2/12/2010 5.71 6.36
2/19/2010 5.92 6.53
2/26/2010 6.06 6.69
3/5/2010 6.71 6.99
3/12/2010 6.91 7.13
3/19/2010 6.72 7.17
3/26/2010 7.03 7.35
4/1/2010 7.13 7.4
4/9/2010 7.32 7.51
4/16/2010 7.8 7.65
4/23/2010 7.99 7.93
4/30/2010 7.69 7.63
5/7/2010 6.74 6.82
5/14/2010 7.18 7.15
5/21/2010 6.28 6.56
5/31/2010 6.93 6.77
PERFORMANCE
Average
Annual
Total
Return
6 Months 1 Year Inception
Ended Ended (5/25/2007)
5/31/2010 5/31/2010 to 5/31/2010
--------- --------- ------------
Fund Performance (3)
NAV 18.31% 68.53% -18.58%
Market Value 33.38% 86.43% -19.19%
Index Performance
Blended Benchmark (4) 3.02% 28.29% N/A(5)
MSCI U.S. Investable Market Financials Index 3.52% 22.97% -23.63%
% OF TOTAL
TOP 10 HOLDINGS INVESTMENTS
--------------- -----------
Ares Capital Corp. 11.0%
MVC Capital, Inc. 6.9
PennantPark Investment Corp. 6.8
Apollo Investment Corp. 5.7
BlackRock Kelso Capital Corp. 5.5
Annaly Capital Management, Inc. 5.1
Solar Capital, Ltd. 4.8
Hercules Technology Growth Capital, Inc. 4.3
Gladstone Capital Corp. 4.2
Prospect Capital Corp. 3.7
----
Total 58.0%
====
% OF TOTAL
ASSET CLASSIFICATION INVESTMENTS
-------------------- -----------
Common Stocks:
Business Development Companies 74.8%
Residential Mortgage REITs 13.6
Domestic 8.1
Specialty Finance/Hybrid REITs 1.5
Exchange-Traded Funds 1.9
Warrants 0.1
Canadian Income Trusts * 0.0
-----
Total 100.0%
=====
* Amount is less than 0.1%.
% OF TOTAL
INDUSTRY INVESTMENTS
-------- -----------
Capital Markets 73.7%
Real Estate Investment Trusts (REITs) 15.2
Diversified Financial Services 5.4
Insurance 3.6
Thrifts & Mortgage Finance 1.5
Health Care Equipment & Supplies 0.6
-----
Total 100.0%
=====
(1) Most recent distribution paid or declared through 5/31/2010. Subject to
change in the future.
(2) Distribution rates are calculated by annualizing the most recent
distribution paid or declared through the report date and then dividing by
Common Share price or NAV as applicable, as of 5/31/2010. Subject to change
in the future.
(3) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by the
Dividend Reinvestment Plan, and changes in NAV per share for net asset
value returns and changes in Common Share price for market value returns.
Total returns do not reflect sales load and are not annualized for periods
less than one year. Past performance is not indicative of future results.
(4) Blended benchmark consists of the following (Source: Bloomberg):
Red Rocks Global Listed Private Equity Index (70%)
FTSE NAREIT Mortgage REIT Index (20%)
S&P SmallCap Financials Index (10%)
(5) Previously, the blended benchmark consisted of the following:
Red Rocks Listed Private Equity Index (40%)
FTSE NAREIT Mortgage REIT Index (20%)
FTSE NAREIT Hybrid REIT Index (20%)
Merrill Lynch Preferred Stock Hybrid Securities Index (10%)
Russell 2000 Financial Services Index (10%)
Certain of these indices were discontinued during 2009, therefore the
blended benchmark was changed. See footnote (4) above for the new blended
benchmark constituents. As certain of the indices in the new blended
benchmark began subsequent to the inception date (5/25/2007) of the Fund,
the average annual total return from inception to 5/31/2010 for the blended
benchmark cannot be calculated.
Page 2
PORTFOLIO COMMENTARY
SUB-ADVISOR
Confluence Investment Management LLC ("Confluence" or the "Sub-Advisor"), a
registered investment advisor located in Saint Louis, Missouri, has served as
the Sub-Advisor to First Trust Specialty Finance and Financial Opportunities
Fund (NYSE: FGB) since July 29, 2008. The investment professionals at Confluence
have over 80 years of aggregate portfolio management experience. Confluence
professionals have invested in a wide range of specialty finance and other
financial company securities during various market cycles, working to provide
attractive risk-adjusted returns to clients.
PORTFOLIO MANAGEMENT TEAM
MARK A. KELLER, CFA - CHIEF EXECUTIVE OFFICER AND CHIEF INVESTMENT OFFICER
(PHOTO OF MARK A. KELLER)
Mr. Keller has 30 years of investment experience with a focus on value-oriented
equity analysis and management. From 1994 to May 2008, he was the Chief
Investment Officer of Gallatin Asset Management, Inc., and its predecessor
organization, A.G. Edwards Asset Management, the investment management arm of
A.G. Edwards, Inc. From 1999 to 2008, Mr. Keller was Chairman of A.G. Edwards'
Investment Strategy Committee, which set investment policy and established asset
allocation models for the entire organization. Mr. Keller was a founding member
of the A.G. Edwards Investment Strategy Committee, on which he served for over
20 years, the last ten years as Chairman of the Committee. Mr. Keller began his
career with A.G. Edwards in 1978, serving as an equity analyst for the firm's
Securities Research Department from 1979 to 1994. During his last five years in
Securities Research, Mr. Keller was Equity Strategist and manager of the firm's
Focus List. He was a Senior Vice President of A.G. Edwards & Sons, Inc. and of
Gallatin Asset Management, Inc., and was a member of the Board of Directors of
both companies. Mr. Keller received a Bachelor of Arts from Wheaton College
(Illinois) and is a CFA charterholder.
DAVID B. MIYAZAKI, CFA - SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER
(PHOTO OF DAVID B. MIYAZAKI)
Prior to joining Confluence in May 2008, Mr. Miyazaki served as a Portfolio
Manager and Analyst with Gallatin Asset Management, Inc., the investment
management arm of A.G. Edwards, Inc. Mr. Miyazaki was responsible for equity
investments in value-oriented separately managed accounts. He also co-managed
the A.G. Edwards' ETF-based asset allocation program. In addition to portfolio
management, Mr. Miyzazki served as a member of the A.G. Edwards' Investment
Strategy Committee. As a strategist, he was responsible for the firm's
quantitative asset allocation models, including its Cyclical Asset Allocation
program. Prior to joining A.G. Edwards in 1999, Mr. Miyazaki was a Portfolio
Manager at Koch Industries in Wichita, Kansas. His previous experience includes
working as an Investment Analyst at Prudential Capital Group in Dallas, Texas,
and as a Bond Trader at Barre & Company, also in Dallas. Mr. Miyazaki received a
Bachelor of Business Administration from Texas Christian University and is a CFA
charterholder.
DANIEL T. WINTER, CFA - SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER
(PHOTO OF DANIEL T. WINTER)
Prior to joining Confluence in May 2008, Mr. Winter served as a Portfolio
Manager and Analyst with Gallatin Asset Management, Inc., the investment arm of
A.G. Edwards, Inc. While at Gallatin, Mr. Winter chaired the portfolio
management team responsible for the firm's six value-oriented equity strategies.
His responsibilities also included directing the strategy implementation and
trading execution for the equity portfolios. Mr. Winter also served as a
portfolio manager for the Cyclical Growth ETF Portfolio and the Cyclical Growth
and Income ETF Portfolio which were offered through variable annuities. He was
also a member of the firm's Allocation Advisor Committee which oversaw the A.G.
Edwards exchange-traded fund focused strategies. Prior to joining the firm's
Asset Management division in 1996, Mr. Winter served as a portfolio manager for
A.G. Edwards Trust Company. Mr. Winter earned a Bachelor of Arts in business
management from Eckerd College and a Master of Business Administration from
Saint Louis University. Mr. Winter is a CFA charterholder.
Page 3
PORTFOLIO COMMENTARY (CONTINUED)
COMMENTARY
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND (FGB)
The primary investment objective of the First Trust Specialty Finance and
Financial Opportunities Fund ("FGB" or the "Fund") is to seek a high level of
current income. As a secondary objective, the Fund seeks an attractive total
return. The Fund pursues its investment objectives by investing at least 80% of
its managed assets in a portfolio of securities of specialty finance and other
financial companies that the Fund's Sub-Advisor believes offer attractive
opportunities for income and capital appreciation. There can be no assurance
that the Fund's investment objectives will be achieved. The Fund may not be
appropriate for all investors.
MARKET RECAP
FGB is a financial sector fund with a particular focus on a niche called
business development companies ("BDCs"). BDCs lend to and invest in private
companies, often working with those not large enough to efficiently access the
public markets. Each BDC has a unique profile, determined by its respective
management teams. Some specialize in particular industries, while others apply a
more generalized approach and maintain a diversified portfolio. Both approaches
can work effectively and deliver to shareholders a unique and differentiated
return opportunity derived from the private markets. As of May 31, 2010, the
Fund had almost three quarters of its assets invested in 21 BDCs.
The Fund began its fiscal 2010 year in a strong fashion, building upon the
broader market recovery that began in the spring of 2009. Although the magnitude
of the recovery was dramatic, valuations in areas where the Fund is focused,
most notably in BDCs and mortgage REITs, remained below their historical
averages. This profile enabled many of the Fund's positions to continue
appreciating well into 2010.
In May, concerns regarding sovereign credit risks in Europe began to rise,
sparking fear that a liquidity crisis like the 2008 experience was beginning.
Investors began to migrate out of investments with credit risk, moving instead
into investments with little, if any, credit risk, like U.S. Treasury
securities. These concerns were also evident in currency trends, where the Euro
weakened substantially relative to the U.S. dollar. In general, U.S. stocks
declined, while equity volatility rose. The financial sector was among the
hardest hit, reflecting investor uncertainty regarding how widespread and deep
European sovereign debt problems might become.
BDCs and the vast majority of the Fund's other holdings generally don't have
direct exposure to European sovereign debt. Still, when evaluating the financial
sector, it is important to monitor the issues that can affect broad market
liquidity, which does directly impact financial companies. At this point, we do
not anticipate European sovereign debt problems to expand into a liquidity
crisis like that of 2008. We believe the issue will remain principally a
European challenge, given that U.S. exposure to struggling European countries is
not widespread and because investor leverage levels are much lower today than
they were going into 2008.
Over the period, looking more specifically at the Fund's areas of focus, BDCs
continued to consolidate, repair and grow. Weaker BDCs, like Patriot Capital and
Allied Capital, were acquired by stronger, healthier BDCs. In addition, BDC
valuations improved to the point where many were able to raise equity capital in
an accretive manner, pricing new shares at a premium to net asset values. And
finally, for the first time in many quarters, new BDCs had initial public
offerings. Solar Capital, Golub Capital and THL Credit are three new public
BDCs, and the Fund established positions in each of them. It is a positive trend
to see the formation of new, quality BDCs, as it indicates that growth is
returning to the industry.
The second-largest exposure for the Fund is in mortgage REITs. Valuations moved
lower as concerns regarding policy decisions from Federal Reserve, Freddie Mac
and Fannie Mae created uncertainty and volatility in mortgage-backed securities.
However, we continue to view this industry favorably. Returns on equity are
attractive, while leverage and valuation levels remain well below historical
trends. We believe these positions are constructive in pursuing the Fund's
income objectives.
SIX MONTHS
PERFORMANCE ANALYSIS ENDED 5/31/10
FGB Market Value Total Return 33.38%
FGB NAV Total Return 18.31%
Blended Benchmark* 3.02%
* Components of the blended benchmark: Red Rocks Global Listed Private Equity
Index (70%); FTSE NAREIT Mortgage REIT Index (20%); S&P SmallCap Financials
Index (10%). Source: Bloomberg
Page 4
PORTFOLIO COMMENTARY (CONTINUED)
The Fund's market value total return (+33.38%)(1) was higher than the Fund's NAV
total return (+18.31%)(1) as the discount to NAV (-9.20%) changed to a premium
(+2.36%) during the six months ended May 31, 2010. The strong performance was
derived from improving valuations, stabilizing fundamentals and positive
dividend trends in the Fund's portfolio. The Fund also outperformed its blended
benchmark (+3.02%).
The Fund maintained larger positions in BDCs with high quality portfolios and
management teams, and stable balance sheets. Many of these larger positions,
including Ares Capital, MVC Capital, PennantPark, Apollo Investment and
Blackrock Kelso, performed particularly well.
The Fund's positions in MBS REITs performed lower than that of most BDCs,
hampered by the aforementioned concerns regarding the policies of the Federal
Reserve, Freddie Mac and Fannie Mae. High prepayment activity created
substantial volatility in mortgage cashflows. Valuations in the industry
remained low, even as income generation was high.
MARKET AND FUND OUTLOOK
The financial sector continues to face ongoing challenges as it moves past the
recovery stage and into a more "normalized" environment. Arriving into "normal"
has been hampered by uncertainty regarding European sovereign debt, while
financial market regulatory reforms are redefining the meaning of normal. The
last month (May) of the first half of fiscal 2010 reflected this uncertainty and
was the weakest for many of the Fund's holdings. With growing risk aversion in
the markets, valuations for financial companies, and the assets they hold,
declined.
Paradoxically, growing risk aversion and lower valuations are the source of many
opportunities, both for the companies owned by the Fund as well as for the Fund
itself. Companies are able to invest their capital at more profitable levels
when risk aversion grows, while the Fund can buy these companies at lower
prices.
The Fund maintains an emphasis on companies with the resources to take advantage
of opportunities that arise when capital in the markets becomes scarce. Included
on this list are the three new public BDCs that recently raised equity. To make
room for these positions, we trimmed back the Fund's exposure to companies with
fewer capital resources and less flexibility. We believe this strategy can
position the Fund to grow its income and NAV over time.
In recent quarters, we have included positions in the Fund's portfolio of
companies that contribute more return potential from capital appreciation, as
opposed to dividends. Many of these companies have long track records of
increasing book value by retaining and compounding earnings. We believe these
companies provide an opportunity to add to the Fund's NAV accretion, and
complement the Fund's unique financial sector focus on BDCs. It is our pleasure
to manage FGB and we look forward to delivering the income and growth objectives
of the Fund.
----------
(1) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by the
Dividend Reinvestment Plan and changes in net asset value for NAV total
returns and changes in Common Share price for market value returns. Total
returns do not reflect sales load. Past performance is not indicative of
future results.
Page 5
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
PORTFOLIO OF INVESTMENTS (a)
MAY 31, 2010 (UNAUDITED)
SHARES DESCRIPTION VALUE
------ ------------------------------------------------- -----
COMMON STOCKS - 114.1%
CAPITAL MARKETS - 83.6%
616,806 Apollo Investment Corp.(b)(c) ................... $ 6,433,287
911,233 Ares Capital Corp.(b)(c) ........................ 12,338,095
584,320 BlackRock Kelso Capital Corp.(b)(c) ............. 6,135,360
304,366 Fifth Street Finance Corp.(b)(c) ................ 3,472,816
420,716 Gladstone Capital Corp.(b)(c) ................... 4,741,469
183,333 Gladstone Investment Corp.(c) ................... 980,832
203,800 Golub Capital BDC, Inc.(b)(c)(d) ................ 2,863,390
97,768 GSC Investment Corp.(c)(d) ...................... 167,183
544,556 Hercules Technology Growth Capital, Inc.(b)(c) .. 4,797,538
338,063 Kohlberg Capital Corp.(c) ....................... 1,639,606
19,774 Main Street Capital Corp.(b)(c) ................. 287,909
233,600 MCG Capital Corp.(b)(c)(d) ...................... 1,273,120
603,700 MVC Capital, Inc.(b)(c) ......................... 7,775,656
351,637 NGP Capital Resources Co.(b)(c) ................. 2,563,434
764,000 PennantPark Investment Corp.(b)(c) .............. 7,659,100
404,176 Prospect Capital Corp.(b)(c) .................... 4,167,055
252,598 Solar Capital, Ltd.(c)(d) ....................... 5,390,441
195,267 THL Credit, Inc.(b)(c)(d) ....................... 2,310,009
303,837 TICC Capital Corp.(b)(c) ........................ 2,500,578
218,601 Triangle Capital Corp.(b)(c) .................... 3,056,042
-----------
80,552,920
-----------
DIVERSIFIED FINANCIAL SERVICES - 6.3%
187,500 Compass Diversified Holdings(b) ................. 2,703,750
459,504 Medallion Financial Corp.(b)(c) ................. 3,377,354
-----------
6,081,104
-----------
HEALTH CARE EQUIPMENT & SUPPLIES - 0.7%
59,075 Medical Action Industries, Inc.(b)(d) ........... 672,273
-----------
INSURANCE - 4.2%
3 Berkshire Hathaway, Inc., Class A(b)(d) ......... 317,730
83,700 Fidelity National Financial, Inc., Class A(b) ... 1,206,954
3,250 Markel Corp.(b)(d) .............................. 1,123,038
38,475 W.R. Berkley Corp.(b) ........................... 1,048,828
1,000 Wesco Financial Corp.(b) ........................ 353,850
-----------
4,050,400
-----------
REAL ESTATE INVESTMENT TRUSTS (REITS) - 17.6%
339,500 Annaly Capital Management, Inc. (b) ............. 5,757,920
135,706 Cypress Sharpridge Investments, Inc. (b) ........ 1,776,392
192,307 Cypress Sharpridge Investments, Inc. (e) ........ 2,517,299
46,282 Hatteras Financial Corp. (b) .................... 1,282,011
100,000 Hatteras Financial Corp. (e) .................... 2,770,000
150,000 MFA Financial, Inc. (b) ......................... 1,099,500
550,049 NorthStar Realty Finance Corp. (b) .............. 1,732,654
-----------
16,935,776
-----------
See Notes to Financial Statements
Page 6
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
MAY 31, 2010 (UNAUDITED)
SHARES/
UNITS DESCRIPTION VALUE
------- ---------------------------------------------------------- -------------
COMMON STOCKS - (CONTINUED)
THRIFTS & MORTGAGE FINANCE - 1.7%
100,000 Northwest Bancshares, Inc. (b) ........................... $ 1,163,000
35,584 People's United Financial, Inc. (b) 497,108
------------
1,660,108
------------
TOTAL COMMON STOCKS
(Cost $139,103,556) ................................... 109,952,581
------------
EXCHANGE-TRADED FUNDS - 2.2%
CAPITAL MARKETS - 2.2%
55,000 SPDR Barclays Capital High Yield Bond ETF (b) ............ 2,079,550
------------
TOTAL EXCHANGE-TRADED FUNDS
(Cost $1,864,608) ..................................... 2,079,550
------------
CANADIAN INCOME TRUSTS - 0.0%
OIL, GAS & CONSUMABLE FUELS - 0.0%
100 ARC Energy Trust ......................................... 1,967
81 Progress Energy Resources Corp. .......................... 927
------------
TOTAL CANADIAN INCOME TRUSTS
(Cost $3,343) ......................................... 2,894
------------
WARRANTS - 0.1%
REAL ESTATE INVESTMENT TRUSTS (REITS) - 0.1%
576,923 Cypress Sharpridge Investments, Inc., expires 04/30/11,
with an exercise price of $11 per share (d) (e) (f) ...... 123,404
------------
TOTAL WARRANTS
(Cost $0) ............................................. 123,404
------------
TOTAL INVESTMENTS - 116.4%
(Cost $140,971,507) (g) ............................... 112,158,429
OUTSTANDING LOAN - (17.6)% ............................... (17,000,000)
NET OTHER ASSETS AND LIABILITIES - 1.2% .................. 1,167,210
------------
NET ASSETS - 100.0%. ..................................... $ 96,325,639
============
----------
(a) All percentages shown in the Portfolio of Investments are based on net
assets.
(b) All or a portion of this security is available to serve as collateral on
the outstanding loan.
(c) Business Development Company.
(d) Non-income producing security.
(e) This security, sold within the terms of a private placement memorandum, is
exempt from registration under Rule 144A under the Securities Act of 1933,
as amended, and may be resold in transactions exempt from registration,
normally to qualified institutional buyers (see Note 2C - Restricted
Securities in the Notes to Financial Statements).
(f) Security is fair valued in accordance with procedures adopted by the Fund's
Board of Trustees.
(g) Aggregate cost for financial reporting purposes, which approximates the
aggregate cost for federal income tax purposes. As of May 31, 2010, the
aggregate gross unrealized appreciation for all securities in which there
was an excess of value over tax cost was $7,405,237 and the aggregate gross
unrealized depreciation for all securities in which there was an excess of
tax cost over value was $36,218,315.
See Notes to Financial Statements
Page 7
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
MAY 31, 2010 (UNAUDITED)
VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of May 31, 2010
is as follows (see Note 2A - Portfolio Valuation in the Notes to Financial
Statements):
TOTAL LEVEL 2 LEVEL 3
MARKET LEVEL 1 SIGNIFICANT SIGNIFICANT
VALUE AT QUOTED OBSERVABLE UNOBSERVABLE
5/31/2010 PRICES INPUTS INPUTS
------------ ------------ ----------- ------------
Common Stocks * ........... $109,952,581 $109,952,581 $ -- $--
Exchange-Traded Funds * ... 2,079,550 2,079,550 -- --
Canadian Income Trusts * .. 2,894 2,894 -- --
Warrants * ................ 123,404 -- 123,404 --
------------ ------------ -------- ---
TOTAL INVESTMENTS ......... $112,158,429 $112,035,025 $123,404 $--
============ ============ ======== ===
* See Portfolio of Investments for industry breakout.
See Notes to Financial Statements
Page 8
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENT OF ASSETS AND LIABILITIES
MAY 31, 2010 (UNAUDITED)
ASSETS:
Investments, at value
(Cost $140,971,507) ....................................................................... $ 112,158,429
Cash ......................................................................................... 1,002,023
Prepaid expenses ............................................................................. 81,521
Receivables:
Investment securities sold ................................................................ 1,025,670
Dividends ................................................................................. 421,877
Interest .................................................................................. 322
-------------
Total Assets ........................................................................... 114,689,842
-------------
LIABILITIES:
Outstanding loan ............................................................................. 17,000,000
Payables:
Investment securities purchased ........................................................... 1,183,165
Investment advisory fees .................................................................. 99,517
Audit and tax fees ........................................................................ 30,124
Printing fees ............................................................................. 20,659
Administrative fees ....................................................................... 9,454
Trustees' fees and expenses ............................................................... 6,395
Transfer agent fees ....................................................................... 5,158
Interest and fees on loan ................................................................. 3,867
Legal fees ................................................................................ 3,749
Custodian fees ............................................................................ 1,985
Other liabilities ............................................................................ 130
-------------
Total Liabilities ............................................................................ 18,364,203
-------------
NET ASSETS ................................................................................... $ 96,325,639
=============
NET ASSETS CONSIST OF:
Paid-in capital .............................................................................. $ 267,581,726
Par value .................................................................................... 142,313
Accumulated net investment income (loss) ..................................................... (1,022,242)
Accumulated net realized gain (loss) on investments .......................................... (141,563,080)
Net unrealized appreciation (depreciation) on investments .................................... (28,813,078)
-------------
NET ASSETS ................................................................................... $ 96,325,639
=============
NET ASSET VALUE, per Common Share (par value $0.01 per Common Share) ......................... $ 6.77
=============
Number of Common Shares outstanding (unlimited number of Common Shares has been authorized) .. 14,231,333
=============
See Notes to Financial Statements
Page 9
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MAY 31, 2010 (UNAUDITED)
INVESTMENT INCOME:
Dividends (net of foreign withholding tax of $11) .................... $ 6,019,625
Interest ............................................................. 2,754
------------
Total investment income ........................................... 6,022,379
------------
EXPENSES:
Investment advisory fees ............................................. 566,920
Interest and fees on loan ............................................ 155,937
Administration fees .................................................. 54,399
Printing fees ........................................................ 38,548
Audit and tax fees ................................................... 24,924
Legal fees ........................................................... 19,927
Trustees' fees and expenses .......................................... 19,450
Transfer agent fees .................................................. 15,535
Custodian fees ....................................................... 7,734
Excise tax expense ................................................... (67,628)(a)
Other ................................................................ 18,245
------------
Total expenses .................................................... 853,991
------------
NET INVESTMENT INCOME (LOSS) ......................................... 5,168,388
------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on investments .............................. (13,425,823)
Net change in unrealized appreciation (depreciation) on investments .. 23,711,950
------------
NET REALIZED AND UNREALIZED GAIN (LOSS) .............................. 10,286,127
------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS ...... $ 15,454,515
============
----------
(a) Refund of prior year excise tax payment/expense.
See Notes to Financial Statements
Page 10
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS
ENDED
5/31/2010 YEAR ENDED
(UNAUDITED) 11/30/2009
------------ ------------
OPERATIONS:
Net investment income (loss) ............................................... $ 5,168,388 $ 9,126,521
Net realized gain (loss) ................................................... (13,425,823) (40,464,711)
Net change in unrealized appreciation (depreciation) ....................... 23,711,950 60,809,817
------------ ------------
Net increase (decrease) in net assets resulting from operations ............ 15,454,515 29,471,627
------------ ------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income ...................................................... (4,198,243) (7,773,176)
Return of capital .......................................................... -- (836,780)
------------ ------------
Total distributions to shareholders ........................................ (4,198,243) (8,609,956)
------------ ------------
CAPITAL TRANSACTIONS:
Proceeds from Common Shares reinvested ..................................... -- --
Offering costs ............................................................. -- --
------------ ------------
Net increase (decrease) in net assets resulting from capital transactions .. -- --
------------ ------------
Total increase (decrease) in net assets .................................... 11,256,272 20,861,671
NET ASSETS:
Beginning of period ........................................................ 85,069,367 64,207,696
------------ ------------
End of period .............................................................. $ 96,325,639 $ 85,069,367
============ ============
Accumulated net investment income (loss) at end of period .................. $ (1,022,242) $ (1,992,387)
============ ============
CAPITAL TRANSACTIONS WERE AS FOLLOWS:
Common Shares at beginning of period ....................................... 14,231,333 14,231,333
Common Shares issued as reinvestment under the Dividend Reinvestment Plan .. -- --
------------ ------------
Common Shares at end of period ............................................. 14,231,333 14,231,333
============ ============
See Notes to Financial Statements
Page 11
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED MAY 31, 2010 (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase in net assets resulting from operations ....................... $ 15,454,515
Adjustments to reconcile net increase (decrease) in net assets resulting
from operations to net cash provided by operating activities:
Purchases of investments ................................................ (19,210,394)
Sales of investments .................................................... 16,283,354
Net realized gain/loss on investments ................................... 13,425,823
Net change in unrealized appreciation/depreciation on investments ....... (23,711,950)
CHANGES IN ASSETS AND LIABILITIES:
Increase in dividends receivable ........................................ (98,840)
Increase in interest receivable ......................................... (301)
Increase in prepaid expenses. ........................................... (74,897)
Decrease in interest and fees on loan payable ........................... (16,985)
Increase in investment advisory fees payable ............................ 18,505
Increase in administrative fees payable ................................. 1,121
Decrease in audit and tax fees payable. ................................. (19,076)
Decrease in printing fees payable ....................................... (14,032)
Decrease in legal fees payable .......................................... (8,234)
Decrease in custodian fees payable ...................................... (497)
Decrease in Trustees' fees and expenses payable. ........................ (316)
Decrease in transfer agent fees payable ................................. (21)
Decrease in other liabilities. .......................................... (1,591)
------------
CASH PROVIDED BY OPERATING ACTIVITIES ...................................... $ 2,026,184
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to Common Shareholders from net investment income ............ (6,190,630)
Issuances of loan .......................................................... 18,500,000
Repayment of loan .......................................................... (15,850,000)
------------
CASH USED IN FINANCING ACTIVITIES .......................................... (3,540,630)
-----------
Decrease in cash ........................................................... (1,514,446)
Cash at beginning of period ................................................ 2,516,469
-----------
CASH AT END OF PERIOD ...................................................... $ 1,002,023
===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest and fees .......................... $ 233,333
===========
See Notes to Financial Statements
Page 12
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD
SIX MONTHS
ENDED YEAR YEAR PERIOD
5/31/2010 ENDED ENDED ENDED
(UNAUDITED) 11/30/2009 11/30/2008 (f) 11/30/2007 (a)
----------- ---------- -------------- --------------
Net asset value, beginning of period ..................... $ 5.98 $ 4.51 $ 13.73 $ 19.10(b)
------- ------- ------- --------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) ............................. 0.36 0.65 1.02 0.70
Net realized and unrealized gain (loss) .................. 0.73 1.43 (8.88) (5.32)
------- ------- ------- --------
Total from investment operations ......................... 1.09 2.08 (7.86) (4.62)
------- ------- ------- --------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income .................................... (0.30) (0.55) (1.27) (0.71)
Return of capital ........................................ -- (0.06) (0.09) --
------- ------- ------- --------
Total from distributions ................................. (0.30) (0.61) (1.36) (0.71)
------- ------- ------- --------
Common Shares offering costs charged to paid-in capital .. -- -- -- (0.04)
------- ------- ------- --------
Net asset value, end of period ........................... $ 6.77 $ 5.98 $ 4.51 $ 13.73
======= ======= ======= ========
Market value, end of period .............................. $ 6.93 $ 5.43 $ 3.29 $ 14.23
======= ======= ======= ========
TOTAL RETURN BASED ON NET ASSET VALUE (c) ................ 18.31% 56.00% (61.38)% (24.53)%
======= ======= ======= ========
TOTAL RETURN BASED ON MARKET VALUE (c) ................... 33.38% 94.18% (72.80)% (25.36)%
======= ======= ======= ========
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) ..................... $96,326 $85,069 $64,208 $193,070
Ratio of total expenses to average net assets ............ 1.75%(d) 2.29% 2.72% 1.99%(d)
Ratio of total expenses to average net assets excluding
interest expense and fees ............................. 1.43%(d) 1.94% 1.73% 1.41%(d)
Ratio of net investment income to average net assets ..... 10.61%(d) 13.36% 9.53% 8.64%(d)
Portfolio turnover rate .................................. 16% 20% 15% 3%
INDEBTEDNESS:
Loan outstanding (in 000's) .............................. $17,000 $14,350 $11,450 $ 36,000
Asset coverage per $1,000 of indebtedness (e) ............ $ 6,666 $ 6,928 $ 6,608 $ 6,363
----------
(a) Initial seed date of April 23, 2007. The Fund commenced operations on May
25, 2007.
(b) Net of sales load of $0.90 per share on initial offering.
(c) Total return is based on the combination of reinvested dividend, capital
gain and return of capital distributions, if any, at prices obtained by the
Dividend Reinvestment Plan, and changes in net asset value per share for
net asset value returns and changes in Common Share price for market value
returns. Total returns do not reflect sales load and are not annualized for
periods less than one year. Past performance is not indicative of future
results.
(d) Annualized.
(e) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the loan outstanding) and dividing by the
outstanding loan balance in 000's.
(f) On July 29, 2008, Confluence Investment Management LLC became the
sub-advisor to the Fund.
See Notes to Financial Statements
Page 13
NOTES TO FINANCIAL STATEMENTS
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
1. FUND DESCRIPTION
First Trust Specialty Finance and Financial Opportunities Fund (the "Fund") is a
non-diversified, closed-end management investment company organized as a
Massachusetts business trust on March 20, 2007, and is registered with the
Securities and Exchange Commission ("SEC") under the Investment Company Act of
1940, as amended (the "1940 Act"). The Fund trades under the ticker symbol FGB
on the New York Stock Exchange ("NYSE").
The Fund's primary investment objective is to seek a high level of current
income. The Fund seeks attractive total return as a secondary objective. Under
normal market conditions, the Fund invests at least 80% of its Managed Assets in
a portfolio of securities of specialty finance and other financial companies
that Confluence Investment Management LLC ("Confluence" or the "Sub-Advisor")
believes offer attractive opportunities for income and capital appreciation.
Under normal market conditions, the Fund concentrates its investments in
securities of companies within industries in the financial sector. "Managed
Assets" means the average daily gross asset value of the Fund (including assets
attributable to the principal amount of borrowings) minus the sum of the Fund's
accrued and unpaid dividends and accrued liabilities (other than the principal
amount of any borrowings incurred by the Fund). There can be no assurance that
the Fund will achieve its investment objectives. The Fund may not be appropriate
for all investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statements. Actual results could differ from those estimates.
A. PORTFOLIO VALUATION:
The net asset value ("NAV") of the Common Shares of the Fund is determined daily
as of the close of regular trading on the NYSE, normally 4:00 p.m. Eastern time,
on each day the NYSE is open for trading. Domestic debt securities and foreign
securities are priced using data reflecting the earlier closing of the principal
markets for those securities. The NAV per Common Share is calculated by dividing
the value of all assets of the Fund (including accrued interest and dividends),
less all liabilities (including accrued expenses, dividends declared but unpaid
and any borrowings of the Fund), by the total number of Common Shares
outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value according
to procedures adopted by the Fund's Board of Trustees. A majority of the Fund's
assets are valued using market information supplied by third parties. In the
event that market quotations are not readily available, the pricing service does
not provide a valuation for a particular asset, or the valuations are deemed
unreliable, the Fund's Board of Trustees has designated First Trust Advisors
L.P. ("First Trust") to use a fair value method to value the Fund's securities
and investments. Additionally, if events occur after the close of the principal
markets for particular securities (e.g., domestic debt and foreign securities),
but before the Fund values its assets, that could materially affect NAV, First
Trust may use a fair value method to value the Fund's securities and
investments. The use of fair value pricing by the Fund is governed by valuation
procedures adopted by the Fund's Board of Trustees and in accordance with the
provisions of the 1940 Act.
Portfolio securities listed on any exchange other than the NASDAQ National
Market ("NASDAQ") are valued at the last sale price on the business day as of
which such value is being determined. If there has been no sale on such day, the
securities are valued at the mean of the most recent bid and asked prices on
such day. Securities traded on the NASDAQ are valued at the NASDAQ Official
Closing Price as determined by NASDAQ. Portfolio securities traded on more than
one securities exchange are valued at the last sale price on the business day as
of which such value is being determined at the close of the exchange
representing the principal market for such securities. Portfolio securities
traded in the over-the-counter market, but excluding securities traded on the
NASDAQ, are valued at the closing bid prices. Short-term investments that mature
in less than 60 days when purchased are valued at amortized cost.
Page 14
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
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:
- Level 1 - Level 1 inputs are quoted prices in active markets for
identical securities. An active market is a market in which
transactions for the security occur with sufficient frequency and
volume to provide pricing information on an ongoing basis.
- Level 2 - Level 2 inputs are observable inputs, either directly or
indirectly, and include the following:
- Quoted prices for similar securities in active markets.
- Quoted prices for identical or similar securities in markets that
are non-active. A non-active market is a market where there are
few transactions for the security, 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.
- Inputs other than quoted prices that are observable for the
security (for example, interest rates and yield curves observable
at commonly quoted intervals, volatilities, prepayment speeds,
loss severities, credit risks, and default rates).
- Inputs that are derived principally from or corroborated by
observable market data by correlation or other means.
- Level 3 - Level 3 inputs are unobservable inputs. Unobservable inputs
reflect the reporting entity's own assumptions about the assumptions
that market participants would use in pricing the security.
The inputs or methodology used for valuing securities are not necessarily an
indication of the risk associated with investing in those securities. A summary
of the inputs used to value the Fund's investments as of May 31, 2010, is
included with the Fund's Portfolio of Investments.
B. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on the accrual basis.
The Fund may hold real estate investment trusts ("REITs"). Distributions from
such investments may include a return of capital component from the REIT to the
extent of the cost basis of such REIT investments. The actual character of
amounts received during the year is not known until after the fiscal year end.
The Fund records the character of distributions received from the REITs during
the year based on estimates available. The Fund's characterization may be
subsequently revised based on information received from the REITs after their
tax reporting periods conclude.
The Fund may also hold business development companies ("BDCs"), exchange-traded
funds ("ETFs") and Canadian income trusts ("ClTs"). The tax character of
distributions received from these securities may vary when reported by the
issuer after their tax reporting periods conclude.
C. RESTRICTED SECURITIES:
The Fund invests in restricted securities, which are securities that cannot be
offered for public sale without first being registered under the Securities Act
of 1933, as amended (the "1933 Act"). Prior to registration, restricted
securities may only be resold in transactions exempt from registration under
Rule 144A of the 1933 Act. As of May 31, 2010, the Fund held restricted
securities as shown in the following table. The Fund does not have the right to
demand that such securities be registered. These securities are valued according
to the valuation procedures as stated in the Portfolio Valuation footnote (Note
2A) and are not expressed as a discount to the carrying value of comparable
unrestricted securities.
ACQUISITION SHARES/ % OF
SECURITY DATE UNITS PRICE CARRYING COST VALUE NET ASSETS
-------- ----------- ------- ------ ------------- ---------- ----------
Cypress Sharpridge Investments, Inc. 5/19/08 192,307 $13.09 $2,999,989 $2,517,299 2.61%
Cypress Sharpridge Investments, Inc.,
Warrants 5/19/08 576,923 0.21 -- 123,404 0.13
Hatteras Financial Corp. 1/29/08 100,000 27.70 2,400,000 2,770,000 2.88
---------- ---------- ----
$5,399,989 $5,410,703 5.62%
========== ========== ====
Page 15
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income, if any, of the Fund are declared and paid
quarterly or as the Board of Trustees may determine from time to time.
Distributions of any net capital gains earned by the Fund are distributed at
least annually. Distributions will automatically be reinvested into additional
Common Shares pursuant to the Fund's Dividend Reinvestment Plan unless cash
distributions are elected by the shareholder.
Distributions from income and capital gains are determined in accordance with
income tax regulations, which may differ from accounting principles generally
accepted in the United States of America. These differences are primarily due to
differing treatments of income and gains on various investment securities held
by the Fund, timing differences and differing characterization of distributions
made by the Fund.
The tax character of distributions paid during the fiscal year ended November
30, 2009 was as follows:
Distributions paid from:
Ordinary Income .... $7,773,176
Return of Capital .. 836,780
As of November 30, 2009, the components of distributable earnings on a tax basis
were as follows:
Undistributed Ordinary Income ............... $ --
Net Unrealized Appreciation (Depreciation) .. (56,641,671)
Accumulated Capital and Other Losses ........ (124,020,614)
E. INCOME TAXES:
The Fund intends to continue to qualify as a regulated investment company by
complying with the requirements under Subchapter M of the Internal Revenue Code
of 1986, as amended, which includes distributing substantially all of its net
investment income and net realized gains to shareholders. Accordingly, no
provision has been made for federal or state income taxes.
The Fund intends to utilize provisions of the federal income tax laws, which
allow it to carry a realized capital loss forward for eight years following the
year of 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 November 30, 2009, the
Fund had a capital loss carryforward for federal income tax purposes of
$123,554,849 with $5,166,354, $62,747,095 and $55,641,400 expiring on November
30, 2015, 2016 and 2017, respectively.
Certain capital losses realized after October 31 may be deferred and treated as
occurring on the first day of the following fiscal year. For the fiscal year
ended November 30, 2009, the Fund elected to defer net realized capital losses
of $465,765 incurred between November 1, 2009 and November 30, 2009.
The Fund is subject to accounting standards that establish a minimum threshold
for recognizing, and a system for measuring, the benefits of a tax position
taken or expected to be taken in a tax return. Taxable years ending 2007, 2008
and 2009 remain open to federal and state audit. As of May 31, 2010, management
has evaluated the application of these standards to the Fund, and has determined
that no provision for income tax is required in the Fund's financial statements
for uncertain tax positions.
F. EXPENSES:
The Fund pays all expenses directly related to its operations.
G. NEW ACCOUNTING PRONOUNCEMENT:
In January 2010, the Financial Accounting Standards Board ("FASB") issued
Accounting Standards Update ("ASU") No. 2010-06
"Improving Disclosures about Fair Value Measurements." ASU 2010-06 amends FASB
Accounting Standards Codification Topic 820, Fair Value Measurements and
Disclosures, to require additional disclosures regarding fair value
measurements. Certain disclosures required by ASU No. 2010-06 are effective for
interim and annual reporting periods beginning after December 15, 2009, and
other required disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years.Management
is currently evaluating the impact ASU No. 2010-06 will have on the Fund's
financial statement disclosures, if any.
Page 16
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
3. INVESTMENT ADVISORY FEE, AFFILIATED TRANSACTIONS AND OTHER FEE ARRANGEMENTS
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. First Trust
serves as investment advisor to the Fund pursuant to an Investment Management
Agreement. First Trust is responsible for the ongoing monitoring of the Fund's
investment portfolio, managing the Fund's business affairs and providing certain
administrative services necessary for the management of the Fund. For these
investment management services, First Trust is entitled to a monthly fee
calculated at an annual rate of 1.00% of the Fund's Managed Assets.
Confluence serves as the Fund's sub-advisor and manages the Fund's portfolio
subject to First Trust's supervision. The Sub-Advisor receives a monthly
portfolio management fee calculated at an annual rate of 0.50% of Managed Assets
that is paid by First Trust from its investment advisory fee.
On May 7, 2008, First Trust Portfolios L.P., an affiliate of the Advisor, paid
$200,000 for an equity ownership interest in Confluence, which was subsequently
converted into debt. Accordingly, First Trust Portfolios L.P. currently holds a
promissory note from Confluence with a stated principal amount of $200,000, an
annual interest rate of 3.20% and a stated maturity date of June 30, 2015.
PNC Global Investment Servicing (U.S.) Inc., an indirect, wholly-owned
subsidiary of The PNC Financial Services Group, Inc. ("PNC"), serves as the
Fund's Administrator, Fund Accountant and Transfer Agent in accordance with
certain fee arrangements. PFPC Trust Company, also an indirect, majority-owned
subsidiary of PNC, serves as the Fund's Custodian in accordance with certain fee
arrangements.
On July 1, 2010, The PNC Financial Services Group, Inc. sold the outstanding
stock of PNC Global Investment Servicing Inc. to The Bank of New York Mellon
Corporation. At the closing of the sale, PNC Global Investment Servicing (U.S.)
Inc. changed its name to BNY Mellon Investment Servicing (US) Inc. PFPC Trust
Company will not change its name until a later date to be announced.
Each Trustee who is not an officer or employee of First Trust, any sub-advisor
or any of their affiliates ("Independent Trustees") is paid an annual retainer
of $10,000 per trust for the first 14 trusts of the First Trust Fund Complex and
an annual retainer of $7,500 per trust for each additional trust in the First
Trust Fund Complex. The annual retainer is allocated equally among each of the
trusts. No additional meeting fees are paid in connection with board or
committee meetings.
Additionally, the Lead Independent Trustee is paid $10,000 annually, the
Chairman of the Audit Committee is paid $5,000 annually, and each of the
Chairmen of the Nominating and Governance Committee and the Valuation Committee
are paid $2,500 annually to serve in such capacities, with such compensation
paid by the trusts in the First Trust Fund Complex and divided among those
trusts. Trustees are also reimbursed by the trusts in the First Trust Fund
Complex for travel and out-of-pocket expenses in connection with all meetings.
The Lead Independent Trustee and each Committee chairman will serve two-year
terms ending on December 31, 2011, before rotating to serve as a chairman of
another committee or as Lead Independent Trustee. The officers and "Interested"
Trustee receive no compensation from the Fund for serving in such capacities.
4. PURCHASES AND SALES OF SECURITIES
Cost of purchases and proceeds from sales of investment securities, excluding
U.S. government and short-term investments, for the six months ended May 31,
2010, were $20,165,559 and $17,309,024, respectively.
5. CREDIT AGREEMENTS
The Fund had a Credit Agreement and a Credit Annex thereto with Credit Suisse
Securities (USA) LLC, which provided for an uncommitted credit facility to be
used as leverage for the Fund (the "Credit Suisse Facility"). The Credit Suisse
Facility provided for a secured, uncommitted line of credit for the Fund, where
Fund assets were pledged against advances made to the Fund. The maximum amount
that could be outstanding at any one time under the Credit Suisse Facility was
$70,000,000. On February 17, 2010, all outstanding borrowings, in the amount of
$15,850,000, were paid in full through a committed facility agreement with BNP
Paribas Prime Brokerage Inc. ("BNP").
The daily average amount outstanding between December 1, 2009 and February 17,
2010 under the Credit Suisse Facility was $15,715,385, and the interest rate
during the period December 1, 2009 through February 17, 2010 was 1.73%.
On February 2, 2010, the Fund entered into a committed facility agreement with
BNP (the "BNP Facility") with a maximum commitment amount of $18,000,000. The
committed facility required an upfront payment from the Fund equal to $90,000.
Absent certain events of default or failure to maintain certain collateral
requirements, BNP may not terminate the BNP Facility agreement except upon 180
calendar days prior notice. The borrowing rate under the BNP Facility is equal
to the 3-month LIBOR plus 100 basis points. In addition, under the BNP Facility,
the Fund pays a commitment fee of 0.85% on the undrawn amount and a renewal fee
of $42,500.
Page 17
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
The average amount outstanding between February 17, 2010 and May 31, 2010 under
the BNP Facility was $16,303,365, with a weighted average interest rate of
1.34%. As of May 31, 2010, the Fund had outstanding borrowings of $17,000,000
under this BNP Facility agreement. The high and low annual interest rates during
the period February 17, 2010 through May 31, 2010 were 1.54% and 1.25%,
respectively, and the interest rate at May 31, 2010 was 1.54%.
6. INDEMNIFICATION
The Fund has a variety of indemnification obligations under contracts with its
service providers. The Fund's maximum exposure under these arrangements is
unknown. However, the Fund has not had prior claims or losses pursuant to these
contracts and expects the risk of loss to be remote.
7. RISK CONSIDERATIONS
Risks are inherent in all investing. The following summarizes some of the risks
that should be considered for the Fund. For additional information about the
risks associated with investing in the Fund, please see the Fund's prospectus
and statement of additional information, as well as other Fund regulatory
filings.
INVESTMENT AND MARKET RISK: An investment in the Fund's Common Shares is subject
to investment risk, including the possible loss of the entire principal
invested. An investment in Common Shares represents an indirect investment in
the securities owned by the Fund. The value of these securities, like other
market investments, may move up or down, sometimes rapidly and unpredictably.
Common Shares at any point in time may be worth less than the original
investment, even after taking into account the reinvestment of Fund dividends
and distributions. Security prices can fluctuate for several reasons including
the general condition of the equity market, or when political or economic events
affecting the issuers occur. When the Advisor or Sub-Advisor determines that it
is temporarily unable to follow the Fund's investment strategy or that it is
impractical to do so (such as when a market disruption event has occurred and
trading in the securities is extremely limited or absent), the Fund may take
temporary defensive positions.
FINANCIAL SECTOR CONCENTRATION RISK: Under normal market conditions, the Fund
will invest at least 25% of its total assets in securities of companies within
industries in the financial sector. A fund concentrated in a single industry or
sector is likely to present more risks than a fund that is broadly diversified
over several industries or groups of industries. Compared to the broad market,
an individual sector may be more strongly affected by changes in the economic
climate, broad market shifts, moves in a particular dominant stock, or
regulatory changes. Specialty finance and other financial companies in general
are subject to extensive government regulation, which may change frequently. The
profitability of specialty finance and other financial companies is largely
dependent upon the availability and cost of capital funds, and may fluctuate
significantly in response to changes in interest rates, as well as changes in
general economic conditions. From time to time, severe competition may also
affect the profitability of specialty finance and other financial companies.
Financial companies can be highly dependent upon access to capital markets and
any impediments to such access, such as general economic conditions or a
negative perception in the capital markets of a company's financial condition or
prospects, could adversely affect its business. Leasing companies can be
negatively impacted by changes in tax laws which affect the types of
transactions in which such companies engage.
BUSINESS DEVELOPMENT COMPANY ("BDC") RISK: Investments in closed-end funds that
elect to be treated as BDCs may be subject to a high degree of risk. BDCs
typically invest in small and medium-sized private and certain public companies
that may not have access to public equity markets or capital raising. As a
result, a BDC's portfolio could include a substantial amount of securities
purchased in private placements, and its portfolio may carry risks similar to
those of a private equity or venture capital fund. Securities that are not
publicly registered may be difficult to value and may be difficult to sell at a
price representative of their intrinsic value. Investments in BDCs are subject
to various risks, including management's ability to meet the BDC's investment
objective, and to manage the BDC's portfolio when the underlying securities are
redeemed or sold, during periods of market turmoil and as investors' perceptions
regarding a BDC or its underlying investments change. BDC shares are not
redeemable at the option of the BDC shareholder and, as with shares of other
closed-end funds, they may trade in the secondary market at a discount to their
NAV.
REIT, MORTGAGE-RELATED AND ASSET-BACKED SECURITIES RISKS: Investing in REITs
involves certain unique risks in addition to investing in the real estate
industry in general. REITs are subject to interest rate risk (especially
mortgage REITs) and the risk of default by lessees or borrowers. An equity REIT
may be affected by changes in the value of the underlying properties owned by
the REIT. A mortgage REIT may be affected by the ability of the issuers of its
portfolio of mortgages to repay their obligations. REITs whose underlying assets
are concentrated in properties used by a particular industry are also subject to
risks associated with such industry. REITs may have limited financial resources,
their securities may trade less frequently and in a limited volume, and their
securities may be subject to more abrupt or erratic price movements than larger
company securities.
Page 18
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
In addition to REITs, the Fund may invest in a variety of other mortgage-related
securities, including commercial mortgage securities and other mortgage-backed
instruments. Rising interest rates tend to extend the duration of
mortgage-related securities, making them more sensitive to changes in interest
rates, and may reduce the market value of the securities. In addition,
mortgage-related securities are subject to prepayment risk, the risk that
borrowers may pay off their mortgages sooner than expected, particularly when
interest rates decline. This can reduce the Fund's returns because the Fund may
have to reinvest that money at lower prevailing interest rates.
The Fund's investments in other asset-backed securities are subject to risks
similar to those associated with mortgage-backed securities, as well as
additional risks associated with the nature of the assets and the servicing of
those assets.
LEVERAGE RISK: The use of leverage results in additional risks and can magnify
the effect of any losses. The funds borrowed pursuant to a leverage borrowing
program constitute a substantial lien and burden by reason of their prior claim
against the income of the Fund and against the net assets of the Fund in
liquidation. The rights of lenders to receive payments of interest on and
repayments of principal on any borrowings made by the Fund under a leverage
borrowing program are senior to the rights of holders of Common Shares with
respect to the payment of dividends or upon liquidation. If the Fund is not in
compliance with certain credit facility provisions, the Fund may not be
permitted to declare dividends or other distributions or purchase Common Shares.
NON-DIVERSIFICATION RISK: Because the Fund is non-diversified, it is only
limited as to the percentage of its assets which may be invested in the
securities of any one issuer by the diversification requirements imposed by the
Internal Revenue Code of 1986, as amended. Because the Fund may invest a
relatively high percentage of its assets in a limited number of issuers, the
Fund may be more susceptible to any single economic, political or regulatory
occurrence and to the financial conditions of the issuers in which it invests.
8. SUBSEQUENT EVENTS
Management has evaluated the impact of all subsequent events on the Fund through
the date the financial statements were issued, and has determined that there
were no subsequent events requiring recognition or disclosure in the financial
statements that have not already been disclosed.
Page 19
ADDITIONAL INFORMATION
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Shares will be automatically reinvested by BNY
Mellon Investment Servicing (US) Inc. (formerly PNC Global Investment Servicing
(U.S.) Inc.) (the "Plan Agent"), in additional Common Shares under the Plan. If
you elect to receive cash distributions, you will receive all distributions in
cash paid by check mailed directly to you by the Plan Agent, as dividend paying
agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
(1) If Common Shares are trading at or above NAV at the time of valuation,
the Fund will issue new shares at a price equal to the greater of (i)
NAV per Common Share on that date or (ii) 95% of the market price on
that date.
(2) If Common Shares are trading below NAV at the time of valuation, the
Plan Agent will receive the dividend or distribution in cash and will
purchase Common Shares in the open market, on the NYSE or elsewhere,
for the participants' accounts. It is possible that the market price
for the Common Shares may increase before the Plan Agent has completed
its purchases. Therefore, the average purchase price per share paid by
the Plan Agent may exceed the market price at the time of valuation,
resulting in the purchase of fewer shares than if the dividend or
distribution had been paid in Common Shares issued by the Fund. The
Plan Agent will use all dividends and distributions received in cash
to purchase Common Shares in the open market within 30 days of the
valuation date except where temporary curtailment or suspension of
purchases is necessary to comply with federal securities laws.
Interest will not be paid on any uninvested cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (800) 331-1710, in
accordance with such reasonable requirements as the Plan Agent and the Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized, although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing BNY Mellon Investment
Servicing (US) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809.
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how
to vote proxies and information on how the Fund voted proxies relating to
portfolio securities 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 website at http://www.sec.gov.
Page 20
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available (1) by calling (800)
988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3)
on the SEC's website at http://www.sec.gov; and (4) for review and copying at
the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding
the operation of the PRR may be obtained by calling (800) SEC-0330.
SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
The Joint Annual Meeting of Shareholders of the Common Shares of Macquarie/First
Trust Global Infrastructure/Utilities Dividend & Income Fund, Energy Income and
Growth Fund, First Trust Enhanced Equity Income Fund, First Trust/Aberdeen
Global Opportunity Income Fund, First Trust/FIDAC Mortgage Income Fund, First
Trust Strategic High Income Fund, First Trust Strategic High Income Fund II,
First Trust/Aberdeen Emerging Opportunity Fund, First Trust Strategic High
Income Fund III, First Trust Specialty Finance and Financial Opportunities Fund
and First Trust Active Dividend Income Fund was held on April 14, 2010. At the
Annual Meeting, Trustees James A. Bowen and Niel B. Nielson were elected by the
Common Shareholders of the First Trust Specialty Finance and Financial
Opportunities Fund as Class III Trustees for three-year terms expiring at the
Fund's annual meeting of shareholders in 2013. The number of votes cast in favor
of Mr. Bowen was 13,317,052, the number of votes against was 230,333 and the
number of abstentions was 683,948. The number of votes cast in favor of Mr.
Nielson was 13,312,164, the number of votes against was 235,221 and the number
of abstentions was 683,948. Richard E. Erickson, Thomas R. Kadlec and Robert F.
Keith are the other current and continuing Trustees.
INVESTMENT MANAGEMENT AND SUB-ADVISORY AGREEMENTS
BOARD CONSIDERATIONS REGARDING CONTINUATION OF INVESTMENT MANAGEMENT AND
SUB-ADVISORY AGREEMENTS
The Board of Trustees of First Trust Specialty Finance and Financial
Opportunities Fund (the "Fund"), including the Independent Trustees, unanimously
approved the continuation of the Investment Management Agreement (the "Advisory
Agreement") between the Fund and First Trust Advisors L.P. (the "Advisor") and
the Investment Sub-Advisory Agreement (the "Sub-Advisory Agreement" and together
with the Advisory Agreement, the "Agreements") among the Fund, the Advisor and
Confluence Investment Management LLC (the "Sub-Advisor") at a meeting held on
March 21-22, 2010. The Board determined that the terms of the Agreements are
fair and reasonable and that the Agreements continue to be in the best interests
of the Fund.
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 separate report from each of the Advisor and the
Sub-Advisor in advance of the Board meeting responding to a request for
information from counsel to the Independent Trustees. The reports, among other
things, outlined the services provided by the Advisor and the Sub-Advisor
(including the relevant personnel responsible for these services and their
experience); the advisory and sub-advisory fees for the Fund as compared to fees
charged to other clients of the Advisor and the Sub-Advisor and as compared to
fees charged by investment advisors and sub-advisors to comparable funds;
expenses of the Fund as compared to expense ratios of comparable funds; the
nature of expenses incurred in providing services to the Fund and the potential
for economies of scale, if any; financial data on the Advisor and the
Sub-Advisor; any fall out benefits to the Advisor and the Sub-Advisor; and
information on the Advisor's and the Sub-Advisor's compliance programs. The
Independent Trustees also met separately with their independent legal counsel to
discuss the information provided by the Advisor and the Sub-Advisor. The Board
applied its business judgment to determine whether the arrangements between the
Fund and the Advisor and among the Fund, the Advisor and the Sub-Advisor are
reasonable business arrangements from the Fund's perspective as well as from the
perspective of shareholders.
In reviewing the Agreements, the Board considered the nature, quality and extent
of services provided by the Advisor and the Sub-Advisor under the Agreements.
The Board considered the Advisor's statements regarding the incremental benefits
associated with the Fund's advisor/sub-advisor management structure. With
respect to the Advisory Agreement, the Board considered that the Advisor is
responsible for the overall management and administration of the Fund, including
the oversight of the Sub-Advisor. The Board noted the compliance program that
had been developed by the Advisor and considered that the compliance program
includes policies and procedures for monitoring the Sub-Advisor's compliance
with the 1940 Act and the Fund's investment objectives and policies. The Board
also noted the enhancements made by the Advisor to the compliance program in
2009. With respect to the Sub-Advisory Agreement, the Board received a
presentation from representatives of the Sub-Advisor discussing the services
that the Sub-Advisor provides to the Fund and how the Sub-Advisor manages the
Fund's investments. The Board noted that shareholders had approved the
Sub-Advisory Agreement with the Sub-Advisor at a special meeting held on
November 17, 2008, and that the Sub-Advisor had begun serving as such on July
31,
Page 21
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
MAY 31, 2010 (UNAUDITED)
2008. In light of the information presented and the considerations made, the
Board concluded that the nature, quality and extent of services provided to the
Fund by the Advisor and the Sub-Advisor under the Agreements have been and are
expected to remain satisfactory and that the Sub-Advisor, under the oversight of
the Advisor, has managed the Fund consistent with its investment objectives and
policies.
The Board considered the advisory and sub-advisory fees paid under the
Agreements. The Board considered the advisory fees charged by the Advisor to
similar funds and other non-fund clients, and noted that the Advisor does not
provide advisory services to other clients with investment objectives and
policies similar to the Fund's. The Board also considered information provided
by the Sub-Advisor as to the fees it charges to other similar clients, noting
that the Sub-Advisor does not charge a lower fee to any other client for which
it provides comparable services. In addition, the Board received data prepared
by Lipper Inc. ("Lipper"), an independent source, showing the management fees
and expense ratios of the Fund as compared to the management fees and expense
ratios of a combined peer group selected by Lipper and the Advisor. The Board
discussed with representatives of the Advisor the limitations in creating a
relevant peer group for the Fund, including that (i) the peer funds may use
different types of leverage which have different costs associated with them;
(ii) most peer funds do not employ an advisor/sub-advisor management structure;
(iii) the peer funds may not have the same fiscal year as the Fund, which may
cause the expense data used by Lipper to be measured over different time
periods; and (iv) many of the peer funds are larger than the Fund. The Board
reviewed the Lipper materials, but based on its discussions with the Advisor,
the Board determined that the Lipper data was of limited value for purposes of
its consideration of the renewal of the Agreements.
The Board also considered performance information for the Fund, noting that the
performance information included the Fund's quarterly performance report, which
is part of the process that the Board has established for monitoring the Fund's
performance on an ongoing basis, and had been enhanced to assess portfolio risk
as well. The Board determined that this process continues to be effective for
reviewing the Fund's performance. In addition to the Board's ongoing review of
performance, the Board also received data prepared by Lipper comparing the
Fund's performance to the combined peer group selected by Lipper and the
Advisor, as well as to a larger group. The Board reviewed the Lipper materials,
but for similar reasons to those described above, the Board determined that the
performance data provided by Lipper was of limited value. The Board considered
an analysis prepared by the Advisor on the continued benefits provided by the
Fund's leverage. In addition, the Board considered the market price and net
asset value performance of the Fund since inception, and compared the Fund's
premium/discount to the average and median premium/discount of the combined peer
group, noting that the Fund's premium/discount was generally indicative of the
asset class and market events. Based on the information provided and the Board's
ongoing review of the Fund's performance, the Board concluded that the Fund's
performance was reasonable.
On the basis of all the information provided on the fees, expenses and
performance of the Fund, the Board concluded that the advisory and sub-advisory
fees were reasonable and appropriate in light of the nature, quality and extent
of services provided by the Advisor and Sub-Advisor under the Agreements.
The Board noted that the Advisor has continued to invest in personnel and
infrastructure and considered whether fee levels reflect any economies of scale
for the benefit of shareholders. The Board concluded that the advisory fee
reflects an appropriate level of sharing of any economies of scale at current
asset levels. The Board also considered the costs of the services provided and
profits realized by the Advisor from serving as investment manager to the Fund
for the twelve months ended December 31, 2009, as set forth in the materials
provided to the Board. The Board noted the inherent limitations in the
profitability analysis, and concluded that the Advisor's profitability appeared
to be not excessive in light of the services provided to the Fund. In addition,
the Board considered and discussed any ancillary benefits derived by the Advisor
from its relationship with the Fund and noted that the typical fall out benefits
to the Advisor such as soft dollars are not present. At the meeting, certain
other relationships between the Advisor (or its affiliate) and the Sub-Advisor
were described, and the Board concluded that fall-out benefits received by the
Advisor or its affiliates appear to be limited.
The Board considered that the Sub-Advisor's costs are generally fixed, allowing
for economies of scale with regard to certain costs. The Board considered that
the sub-advisory fee rate was negotiated at arm's length between the Advisor and
the Sub-Advisor. The Board also considered data provided by the Sub-Advisor as
to the profitability of the Sub-Advisory Agreement to the Sub-Advisor. The Board
noted the inherent limitations in this profitability analysis and concluded that
the profitability analysis for the Advisor was more relevant, although the
profitability of the Sub-Advisory Agreement appeared to be not excessive in
light of the services provided to the Fund. The Board noted that the Sub-Advisor
does not maintain any soft-dollar arrangements and that the Sub-Advisor
indicated that, while it has certain other relationships with the Advisor, it
does not receive any material fall out benefits from its relationship to the
Fund.
Based on all of the information considered and the conclusions reached, the
Board, including the Independent Trustees, determined that the terms of the
Agreements continue to be fair and reasonable and that the continuation of the
Agreements is in the best interests of the Fund. No single factor was
determinative in the Board's analysis.
Page 22
This Page Left Blank Intentionally.
This Page Left Blank Intentionally.
(FIRST TRUST LOGO)
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 E. Liberty Drive, Suite 400
Wheaton, IL 60187
INVESTMENT SUB-ADVISOR
Confluence Investment Management LLC
349 Marshall Avenue, Suite 302
Saint Louis, MO 63119
ADMINISTRATOR,
FUND ACCOUNTANT &
TRANSFER AGENT
BNY Mellon Investment Servicing (US) Inc.
301 Bellevue Parkway
Wilmington, DE 19809
CUSTODIAN
PFPC Trust Company
8800 Tinicum Boulevard
Philadelphia, PA 19153
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
ITEM 2. CODE OF ETHICS.
Not applicable.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
Not applicable.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to
shareholders filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Not applicable.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
(a) Not applicable.
(b) There has been no change, as of the date of this filing, in any of the
portfolio managers identified in response to paragraph (a)(1) of this Item
in the registrant's most recently filed annual report on Form N-CSR.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of trustees, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these
controls and procedures required by Rule 30a-3(b) under the 1940 Act
(17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the
Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's second
fiscal quarter of the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Not applicable.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) First Trust Specialty Finance and Financial Opportunities Fund
By (Signature and Title)* /s/ James A. Bowen
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James A. Bowen,
Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date July 20, 2010
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 A. Bowen
------------------------------------
James A. Bowen,
Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date July 20, 2010
By (Signature and Title)* /s/ Mark R. Bradley
------------------------------------
Mark R. Bradley,
Treasurer, Controller, Chief
Financial Officer and Chief
Accounting Officer
(principal financial officer)
Date July 20, 2010
* Print the name and title of each signing officer under his or her
signature.