NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 2021
1. Organization and Significant Accounting Policies
Virtus AllianzGI Diversified Income & Convertible Fund (“Diversified Income & Convertible”), Virtus AllianzGI
Equity & Convertible Income Fund (“Equity & Convertible Income”) and Virtus Dividend, Interest & Premium Strategy Fund (“Dividend, Interest & Premium Strategy”) (each, a “Fund” and, together,
the “Funds”) were organized as Massachusetts business trusts on March 10, 2015, August 20, 2003 and December 12, 2006, respectively. The Funds follow the investment company accounting and reporting guidance of the Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 946 Financial Services – Investment Companies. Prior to commencing operations on May 27, 2015, February 28, 2005, and, February 27, 2007,
respectively, the Funds had no operations other than matters relating to their organization and registration as diversified, closed-end management investment companies registered under the Investment Company
Act of 1940, as amended (the “1940 Act”), and the rules and regulations thereunder.
During the reporting period, Allianz Global
Investors U.S. LLC (“AllianzGI U.S.” or the “Investment Manager”) served as the Funds’ investment manager through January 31, 2021 (see Note 9 for more information). AllianzGI U.S. is an indirect
“wholly-owned” subsidiary of PFP Holdings, Inc. and is a member of Munich-based Allianz Group. Effective February 1, 2021, following shareholder approval of new investment advisory agreements, Virtus Investment Advisers, Inc.
(“VIA”), an indirect, wholly-owned subsidiary of Virtus Investment Partners (“Virtus”), became the Funds’ investment adviser and manages the Funds’ investment programs and general operations of the Funds, including
oversight of the Funds’ subadvisers. AllianzGI U.S. became the sole sub-adviser to Diversified Income & Convertible and Equity & Convertible Income. AllianzGI U.S. and NFJ Investment
Group, LLC, (“NFJ Investments”) became sub-advisers to Dividend, Interest & Premium Strategy. NFJ Investments is a newly organized, indirect wholly-owned subsidiary of Virtus. Additionally,
Virtus Fund Services, LLC., an indirect, wholly owned subsidiary of Virtus, became the administrator for each Fund. These changes are referred to herein collectively as the “Transition.” Please see Note 9 below.
Each Fund has authorized an unlimited amount of common shares with $0.00001 par value.
The preparation of the Funds’ financial statements in accordance with accounting principles generally accepted in the United States of America
(“U.S. GAAP”) requires the Funds’ management to make estimates and assumptions that affect the reported amounts and disclosures in each Fund’s financial statements. Actual results could differ from those estimates.
Like many other companies, the Funds’ organizational documents provide that its officers (“Officers”) and the Board of Trustees of
each Fund (together, the “Board”) are indemnified against certain liabilities arising out of the performance of their duties to the Funds. In addition, both in some of its principal service contracts and in the normal course of its
business, the Funds enter into contracts that provide indemnification to other parties for certain types of losses or liabilities. The Funds’ maximum exposure under these arrangements is unknown as this could involve future claims against the
Funds.
The following is a summary of significant accounting policies consistently followed by the Funds during the reporting period. In
connection with the Transition, starting February 1, 2021, the Funds have been operating pursuant to the valuation policies and procedures used by other VIA-sponsored registered funds, which differ in certain respects from the Funds’
preexisting policies and procedures. Please see Note 9 for additional information regarding the Transition.
59
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
|
|
(a)
|
Valuation of Investments During the Reporting Period
|
Portfolio securities and other financial instruments for which market quotations are readily available are valued at market value. Market values
for various types of securities and other instruments are determined on the basis of closing prices or last sales prices on an exchange or other market, based on quotes or other market information obtained from quotation reporting systems,
established market makers or independent pricing services. Investments in mutual funds are valued at net asset value (“NAV”) as reported on each business day, and under normal circumstances. Exchange-traded funds (“ETFs”) are
valued at their current market trading price. The Funds’ investments are valued daily using prices supplied by an independent pricing service or broker/dealer quotations, or by using the last sale or settlement price on the exchange that is the
primary market for such securities, or the mean between the last bid and ask quotations. The market value for NASDAQ Global Market and NASDAQ Capital Market securities may also be calculated using the NASDAQ Official Closing Price instead of the
last reported sales price. Independent pricing services use information provided by market makers or estimates of market values obtained from yield data relating to investments or securities with similar characteristics.
The Board has adopted procedures for valuing portfolio securities and other financial instruments, such as derivatives, in circumstances where
market quotes are not readily available (including in cases where available market quotes are deemed to be unreliable), and has delegated primary responsibility for applying the valuation methods to the Investment Manager. The Funds’ Valuation
Committee was established by the Board to oversee the implementation of the Funds’ valuation methods and to make fair value determinations on behalf of the Board, as instructed. The Investment Manager monitors the continued appropriateness of
methods applied and identifies circumstances and events that may require fair valuation. The Investment Manager determines if adjustments should be made in light of market changes, events affecting the issuer, or other factors. If the Investment
Manager determines that a valuation method may no longer be appropriate, another valuation method previously approved by the Funds’ Valuation Committee may be selected, or the Funds’ Valuation Committee will be convened to consider the
matter and take any appropriate action in accordance with procedures set forth by the Board. The Board shall review and ratify the appropriateness of the valuation methods and these methods may be amended or supplemented from time to time by the
Funds’ Valuation Committee.
Short-term debt investments having a remaining maturity of 60 days or less are valued at amortized cost
unless the Board or its Valuation Committee determines that particular circumstances dictate otherwise.
Investments initially valued in
currencies other than the U.S. dollar are converted to the U.S. dollar using exchange rates obtained from pricing services. As a result, the NAV of the Fund may be affected by changes in the value of currencies in relation to the U.S. dollar. The
value of securities traded in markets outside the United States or denominated in currencies other than the U.S. dollar may be affected significantly on a day that the New York Stock Exchange (“NYSE”) is closed.
The prices used by the Funds to value investments may differ from the value that would be realized if the investments were sold, and these
differences could be material to the Funds’ financial statements. Each Fund’s NAV is normally determined as of the close of
60
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
regular trading (normally, 4:00 p.m. Eastern Time) on the NYSE on each day the NYSE is open for business. In unusual circumstances, the Board or
the Valuation Committee may in good faith determine the NAV as of 4:00 p.m., Eastern Time, notwithstanding an earlier, unscheduled close or halt of trading on the NYSE.
The prices of certain portfolio securities or financial instruments may be determined at a time prior to the close of regular trading on the NYSE.
In considering whether fair value pricing is required and in determining fair values, the Funds may, among other things, consider significant events (which may be considered to include changes in the value of U.S. securities or securities indices)
that occur after the close of the relevant market and before the time the NAV of the Funds is calculated. With respect to certain foreign securities, the Funds may fair value securities using modeling tools provided by third-party vendors, where
appropriate. The Funds have retained a statistical research service to assist in determining the fair value of foreign securities. This service utilizes statistics and programs based on historical performance of markets and other economic data to
assist in making fair value estimates. Fair value estimates used by the Funds for foreign securities may differ from the value realized from the sale of those securities and the difference could be material to the financial statements. Fair value
pricing may require subjective determinations about the value of a security or other assets, and fair values used to determine the NAV of the Fund may differ from quoted or published prices, or from prices that are used by others, for the same
investments. In addition, the use of fair value pricing may not always result in adjustments to the prices of securities or other assets held by a Fund.
|
|
(b)
|
Fair Value Measurements
|
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit
price”) in an orderly transaction between market participants. The three levels of the fair value hierarchy are described below:
|
|
• Level 1 –
|
quoted prices in active markets for identical investments that the Funds have the ability to access
|
|
|
• Level 2 –
|
valuations based on other significant observable inputs, which may include, but are not limited to, quoted prices
for similar assets or liabilities, interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates or other market corroborated inputs
|
|
|
• Level 3 –
|
valuations based on significant unobservable inputs (including the Investment Manager’s or Valuation
Committee’s own assumptions and securities whose price was determined by using a single broker’s quote)
|
The
valuation techniques used by the Funds to measure fair value during the year ended January 31, 2021 were intended to maximize the use of observable inputs and to minimize the use of unobservable inputs.
An investment asset’s or liability’s level within the fair value hierarchy is based on the lowest level input, individually or in
aggregate, that is significant to the fair value measurement. The objective of fair value measurement remains the same even when there is a significant decrease in the volume and level of activity for an asset or liability and regardless of the
valuation techniques used.
61
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.
The following are certain inputs and techniques that the Funds generally use to evaluate how to classify each major category of assets and liabilities within Level 2 and Level 3, in accordance with U.S. GAAP.
An asset or liability for which market values cannot be measured using the methodologies described above is valued by methods deemed reasonable in
good faith by the Valuation Committee, following the procedures established by the Board, to represent fair value. Under these procedures, the Funds generally use a market-based approach which may use related or comparable assets or liabilities,
recent transactions, market multiples, book values and other relevant information. Fair value determinations involve the consideration of a number of subjective factors, an analysis of applicable facts and circumstances and the exercise of judgment.
As a result, it is possible that the fair value for a security determined in good faith in accordance with the Funds’ valuation procedures may differ from valuations for the same security determined by other funds using their own valuation
procedures. Although the Funds’ valuation procedures are designed to value a security at the price the Funds may reasonably expect to receive upon the security’s sale in an orderly transaction, there can be no assurance that any fair value
determination thereunder would, in fact, approximate the amount that the Funds would actually realize upon the sale of the security or the price at which the security would trade if a reliable market price were readily available.
Equity Securities (Common and Preferred Stock and Warrants) — Equity securities are valued at the official closing price (typically
last sale) on the exchange on which the securities are primarily traded or, if no closing price is available, at the last bid price and are categorized as Level 1 in the hierarchy. Equity securities traded in inactive markets are valued using inputs
which include broker-dealer quotes, recently executed transactions adjusted for changes in the benchmark index, or evaluated price quotes received from independent pricing services that take into account the integrity of the market sector and
issuer, the individual characteristics of the security, and information received from broker-dealers and other market sources pertaining to the issuer or security. To the extent that these inputs are observable, the values of equity securities are
categorized as Level 2. To the extent that these inputs are unobservable, the values are categorized as Level 3.
Convertible
Bonds & Notes — Convertible bonds & notes are valued by independent pricing services based on various inputs and techniques, which include broker-dealer quotations from relevant market makers and recently
executed transactions in securities of the issuer or comparable issuers. The broker-dealer quotations received are supported by credit analysis of the issuer that takes into consideration credit quality assessments, daily trading activity, and the
activity of the underlying equities, listed bonds and sector-specific trends. To the extent that these inputs are observable, the values of convertible bonds & notes are categorized as Level 2. To the extent that these inputs are
unobservable, the values are categorized as Level 3.
Corporate Bonds & Notes — Corporate
bonds & notes are generally comprised of two main categories: investment grade bonds and high yield bonds. Investment grade bonds are valued by independent pricing services using various inputs and techniques, which include broker-dealer
quotations, live trading levels, recently executed transactions in securities of the issuer or comparable issuers, and option adjusted spread models that include base curve and spread curve inputs. Adjustments to
62
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
individual bonds can be applied to recognize trading differences compared to other bonds issued by the same issuer. High yield bonds are valued by
independent pricing services based primarily on broker-dealer quotations from relevant market makers and recently executed transactions in securities of the issuer or comparable issuers. The broker-dealer quotations received are supported by credit
analysis of the issuer that takes into consideration credit quality assessments, daily trading activity, and the activity of the underlying equities, listed bonds and sector-specific trends. To the extent that these inputs are observable, the values
of corporate bonds & notes are categorized as Level 2. To the extent that these inputs are unobservable, the values are categorized as Level 3.
Option Contracts — Option contracts traded
over-the-counter (“OTC”) and FLexible EXchange (“FLEX”) options are valued by independent pricing services based on pricing models that incorporate
various inputs such as interest rates, credit spreads, currency exchange rates and volatility measurements for in-the-money, at-the-money, and out-of-the-money contracts based on a given strike price. To the
extent that these inputs are observable, the values of OTC and FLEX option contracts are categorized as Level 2. To the extent that these inputs are unobservable, the values are categorized as Level 3.
Senior Loans — Senior Loans generally are valued by independent pricing services based on the average of quoted prices received from
multiple dealers or valued relative to other benchmark securities when broker-dealer quotes are unavailable. These quoted prices are based on interest rates, yield curves, option adjusted spreads, credit spreads and/or other criteria. To the extent
that these inputs are observable, the values of Senior Loans are categorized as Level 2. To the extent that these inputs are unobservable, the values are categorized as Level 3.
|
|
(c)
|
Investment Transactions and Investment Income
|
Investment transactions are accounted for on the trade date. Realized gains and losses on investments are determined on an identified cost basis.
Interest income adjusted for the accretion of discounts and amortization of premiums is recorded on an accrual basis. Discounts or premiums on debt securities purchased are accreted or amortized, respectively, to interest income. Conversion premium
is not amortized. Dividend income is recorded on the ex-dividend date, except for certain dividends from foreign securities where the ex-dividend date may have passed,
and then are recorded as soon after the ex-dividend date as the Funds, using reasonable diligence, become aware of such dividends. Consent fees relating to corporate actions and facility fees and other fees
received after settlement date relating to senior loans and commitment fees received relating to unfunded purchase commitments are recorded as miscellaneous income upon receipt. Payments received from certain investments may be comprised of
dividends, realized gains and return of capital. These payments may initially be recorded as dividend income and may subsequently be reclassified as realized gains and/or return of capital upon receipt of information from the issuer. Payments
considered return of capital reduce the cost basis of the respective security. Distributions, if any, in excess of the cost basis of a security are recognized as capital gains. Expenses are recorded on an accrual basis.
63
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
The Funds intend to distribute all of their taxable income and to comply with the other requirements of Subchapter M of the U.S. Internal Revenue
Code of 1986, as amended, (the “Code”) applicable to regulated investment companies. Accordingly, no provision for U.S. federal income taxes is required. The Funds may be subject to excise tax based on distributions to shareholders.
Accounting for uncertainty in income taxes establishes for all entities, including pass-through entities such as the Funds, a minimum threshold for
financial statement recognition of the benefit of positions taken in filing tax returns (including whether an entity is taxable in a particular jurisdiction), and requires certain expanded tax disclosures. In accordance with provisions set forth
under U.S. GAAP, the Investment Manager has reviewed the Funds’ tax positions for all open tax years. As of January 31, 2021, the Investment Manager has concluded that there are no significant uncertain tax positions that would require
recognition in the Funds’ financial statements. The Funds’ U.S. federal income tax returns for the prior three years, as applicable, remain subject to examination by the Internal Revenue Service.
|
|
(e)
|
Dividends and Distributions to Shareholders
|
Diversified Income & Convertible declares dividends and distributions on a monthly basis. Dividend, Interest & Premium Strategy
and Equity & Convertible Income declare dividends and distributions on a quarterly basis. These dividends and distributions may be comprised in varying proportions of net investment income, gains from option premiums and the sale of
portfolio securities and return of capital. The Funds record dividends and distributions on the ex-dividend date. The amount of dividends from net investment income and distributions from net realized capital
gains or return of capital is determined in accordance with U.S. federal income tax regulations, which may differ from U.S. GAAP. These “book-tax” differences are considered either temporary or
permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their U.S. federal income tax treatment. Temporary differences do not require reclassification. To the
extent dividends and/or distributions exceed current and accumulated earnings and profits for U.S. federal income tax purposes, they are reported as dividends and/or distributions to shareholders from return of capital.
|
|
(f)
|
Convertible Securities
|
The Funds may invest a portion of their assets in convertible securities. Although convertible securities derive part of their value from that of
the securities into which they are convertible, they are not considered derivative financial instruments. However, certain of the Funds’ investments in convertible securities include features which render them sensitive to price changes in
their underlying securities. The value of structured/synthetic convertible securities can be affected by interest rate changes and credit risks of the issuer. Such securities may be structured in ways that limit their potential for capital
appreciation and the entire value of the security may be at risk of loss depending on the performance of the underlying equity security. Consequently, the Funds are exposed to greater downside risk than traditional convertible securities, but
typically still less than that of the underlying stock.
64
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
|
|
(g)
|
Payment In-Kind Securities
|
The Funds may invest in payment in-kind securities, which are debt or preferred stock securities that
require or permit payment of interest in the form of additional securities. Payment in-kind securities allow the issuer to avoid or delay the need to generate cash to meet current interest payments and, as a
result, may involve greater risk than securities that pay interest currently or in cash.
The Funds may receive warrants. Warrants are securities that are usually issued together with a debt security or preferred stock and that give the
holder the right to buy a proportionate amount of common stock at a specified price. Warrants may be freely transferable and are often traded on major exchanges. Warrants normally have a life that is measured in years and entitle the holder to buy
common stock of a company at a price that is usually higher than the market price at the time the warrant is issued. Warrants may entail greater risks than certain other types of investments. Generally, warrants do not carry the right to receive
dividends or exercise voting rights with respect to the underlying securities, and they do not represent any rights in the assets of the issuer. In addition, their value does not necessarily change with the value of the underlying securities, and
they cease to have value if they are not exercised on or before their expiration date. If the market price of the underlying stock does not exceed the exercise price during the life of the warrant, the warrant will expire worthless. Warrants may
increase the potential profit or loss to be realized from the investment as compared with investing the same amount in the underlying securities. Similarly, the percentage increase or decrease in the value of an equity security warrant may be
greater than the percentage increase or decrease in the value of the underlying common stock. Warrants may relate to the purchase of equity or debt securities. Debt obligations with warrants attached to purchase equity securities have many
characteristics of convertible securities and their prices may, to some degree, reflect the performance of the underlying stock. Debt obligations also may be issued with warrants attached to purchase additional debt securities at the same coupon
rate. A decline in interest rates would permit a Fund to sell such warrants at a profit. If interest rates rise, these warrants would generally expire with no value.
|
|
(i)
|
Statement of Cash Flows
|
U.S. GAAP requires entities providing financial statements that report both financial position and results of operations to also provide a
statement of cash flows for each period for which results of operations are provided, but exempts investment companies meeting certain conditions. One of the conditions is that the fund had little or no debt, based on the average debt outstanding
during the period, in relation to average total assets. Diversified Income & Convertible’s indebtedness has been determined to be at a level requiring a statement of cash flows. The Statement of Cash Flows has been prepared using the
indirect method which required net change in net assets resulting from operations to be adjusted to reconcile to net cash flows from operating activities. Dividend, Interest & Premium Strategy and Equity & Convertible Income do not
require a Statement of Cash Flows.
65
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
|
|
(j)
|
Loan Interest Expense
|
Loan interest expense relates to the Diversified Income & Convertible’s participation in debt financing transactions (See Note 7 and
Note 8). Interest expense is recorded as it is incurred.
|
|
(k)
|
Repurchase Agreements
|
The Funds are parties to Master Repurchase Agreements (“Master Repo Agreements”) with select counterparties. The Master Repo Agreements
include provisions for the initiation of repurchase transactions, income payments, events of default, and maintenance of collateral.
The Funds
enter into transactions, under the Master Repo Agreements, with their custodian bank or securities brokerage firms whereby they purchase securities under agreements (i.e., repurchase agreements) to resell such securities at an agreed upon
price and date. The Funds, through their custodian, take possession of securities collateralizing the repurchase agreement. Such agreements are carried at the contract amount in the financial statements, which is considered to represent fair value.
The collateral that is pledged (i.e. the securities received by the Funds), which consists primarily of U.S. government obligations and asset-backed securities, is held by the custodian bank for the benefit of the Funds until the maturity of
the repurchase agreement. Provisions of the repurchase agreements and the procedures adopted by the Funds require that the market value of the collateral, including accrued interest thereon, be sufficient in the event of default by the counterparty.
If the counterparty defaults under the Master Repo Agreements and the value of the collateral declines or if the counterparty enters an insolvency proceeding, realization of the collateral by the Funds may be delayed or limited. The gross values are
included in the Funds’ Schedules of Investments. As of January 31, 2021, the value of the related collateral exceeded the value of the repurchase agreements for each Fund.
|
|
(l)
|
Restricted Securities
|
The Funds are permitted to invest in securities that are subject to legal or contractual restrictions on resale. These securities generally may be
resold in transactions exempt from registration or to the public if the securities are registered. Disposal of these securities may involve time-consuming negotiations and expenses, and prompt sale at an acceptable price may be difficult.
The Funds may purchase assignments of, and participations in, Senior Loans originated, negotiated and structured by a U.S. or foreign commercial
bank, insurance company, finance company or other financial institution for a lending syndicate of financial institutions (the “Lender”). When purchasing an assignment, the Funds succeed to all the rights and obligations under the loan
agreement with the same rights and obligations as the assigning Lender. Assignments may, however, be arranged through private negotiations between potential assignees and potential assignors, and the rights and obligations acquired by the purchaser
of an assignment may differ from, and be more limited than, those held by the assigning Lender. The Funds may also enter into lending arrangements involving unfunded loan commitments, which are contractual obligations for future funding. Unfunded
loan commitments may include revolving credit facilities, which may obligate the Funds to supply additional cash to the borrower on demand.
66
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
Unfunded loan commitments represent a future obligation in full, even though a percentage of the principal amounts may never be utilized by the
borrower.
The Funds may purchase the securities of distressed companies (including assignments or direct investments), including companies
engaged in restructurings or bankruptcy proceedings. Investments in distressed companies may include senior obligations of an issuer issued in connection with a restructuring under Chapter 11 of the U.S. Bankruptcy Code (commonly known as “debtor-in-possession” or “DIP” financings). Debtor-in-possession
financings generally allow the issuer to continue its operations while reorganizing. Such financings constitute senior liens on unencumbered collateral (i.e., collateral not subject to other creditors’ claims). There is risk that the issuer
under a debtor-in-possession financing will not emerge from Chapter 11 and be forced to liquidate its assets under Chapter 7 of the U.S. Bankruptcy Code. In the event of
liquidation, the Funds’ only recourse would be against the collateral securing the debtor-in-possession financing.
|
|
(n)
|
New Accounting Pronouncements
|
In March 2020, FASB issued Accounting Standards Update (“ASU”), No. 2020-04, Reference Rate Reform (Topic 848) - Facilitation of the
Effects of Reference Rate Reform on Financial Reporting. The amendments in ASU 2020-04 provides optional temporary financial reporting relief from the effect of certain types of contract modifications due to the planned discontinuation of the London
Interbank Offered Rate (“LIBOR”) and other interbank-offered based reference rates as of the end of 2021. ASU 2020-04 is effective for certain reference rate-related modifications that occur during the period March 12, 2020 through
December 31, 2022. Management is currently evaluating the impact, if any, of applying ASU 2020-04.
2. Principal Risks
In the normal course of business, the Funds trade financial instruments and enter into financial transactions where risk of potential loss exists
due to, among other things, changes in the market (market risk) or failure of the other party to a transaction to perform (counterparty risk). The Funds are also exposed to other risks such as, but not limited to, interest rate, credit and leverage
risks.
Interest rate risk is the risk that fixed income securities’ valuations will change because of changes in interest rates. During
periods of rising nominal interest rates, the values of fixed income instruments are generally expected to decline. Conversely, during periods of declining nominal interest rates, the values of fixed income instruments are generally expected to
rise. To the extent that a Fund effectively has short positions with respect to fixed income instruments, the values of such short positions would generally be expected to rise when nominal interest rates rise and to decline when nominal interest
rates decline. A nominal interest rate can be described as the sum of a real interest rate and an expected inflation rate. Fixed income securities with longer durations tend to be more sensitive to changes in interest rates, usually making them more
volatile than securities with shorter durations. Duration is used primarily as a measure of the sensitivity of a fixed income security’s market price to interest rate (i.e., yield) movements. Interest rate changes can be sudden and
unpredictable, and the Funds may lose money as a result of movements in interest rates. High-yield or junk bonds are subject to greater levels of credit and liquidity risk, may be speculative and may decline in value due to increase in interest
rates or an issuer’s deterioration and/or default. The Funds may not be able to hedge against changes
67
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
in interest rates or may choose not to do so for cost or other reasons. In addition, any hedges may not work as intended. The values of equity and
other non-fixed income securities may also decline due to fluctuations in interest rates.
The Funds
are exposed to credit risk, which is the risk of losing money if the issuer or guarantor of a fixed income security is unable or unwilling, or is perceived (whether by market participants, rating agencies, pricing services or otherwise) as unable or
unwilling, to make timely principal and/or interest payments, or to otherwise honor its obligations. Securities are subject to varying degrees of credit risk, which are often reflected in credit ratings.
The market values of securities may decline due to general market conditions (market risk) which are not specifically related to a particular
company, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates, adverse changes to credit markets or adverse investor sentiment. They may also decline due
to factors that affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. Equity securities and equity-related investments generally have greater market price
volatility than fixed income securities, although under certain market conditions fixed income securities may have comparable or greater price volatility. Credit ratings downgrades may also negatively affect securities held by the Funds. Even when
markets perform well, there is no assurance that the investments held by the Funds will increase in value along with the broader market. In addition, market risk includes the risk that local, regional or global events, including geopolitical and
other events may disrupt the economy on a national or global level. For example, events such as war, acts of terrorism, the spread of infectious illness or other public health issues, recessions, or other events could have a significant impact on
the economy or the markets for financial instruments and, as a result, could have a significant impact on a Fund and its investments. As a further example, an outbreak of respiratory disease caused by a novel coronavirus designated as COVID-19 was first detected in China in December 2019 and subsequently spread globally, being designated as a pandemic in early 2020. The transmission of COVID-19 and efforts
to contain its spread have resulted in, among other things, border closings and other significant travel restrictions and disruptions; mandatory stay-at-home and
work-from-home orders in numerous countries, including the United States; significant disruptions to business operations, supply chains and customer activity, as well as mandatory business closures; lower consumer demand for goods and services;
event cancellations and restrictions; cancellations, reductions and other changes in services; significant challenges in healthcare service preparation and delivery; public gathering limitations and prolonged quarantines; and general concern and
uncertainty. These effects have exacerbated the significant risks inherent in market investments, and the COVID-19 pandemic has already meaningfully disrupted the global economy and markets, causing market
losses across a range of asset classes, as well as both heightened market volatility and increased illiquidity for trading. Although the long-term economic fallout of COVID-19 is difficult to predict, it has
the potential to continue to have ongoing material adverse effects on the global economy, the economies of individual countries, and the financial performance of individual issuers, sectors, industries, asset classes, and markets in significant and
unforeseen ways. Health crises caused by the outbreak of COVID-19 may also exacerbate other pre-existing political, social, economic, market and financial risks. The
effects of the outbreak in developing or emerging market countries may be greater due to less established health care systems. The COVID-19 pandemic and its effects may be short term or may last for an
extended period of
68
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
time, and in either case could result in significant market volatility, exchange trading suspensions and closures, declines in global financial
markets, higher default rates, and a substantial economic downturn or recession. Furthermore, the ability of the Investment Adviser or its affiliates to operate effectively, including the ability of personnel to function, communicate and travel to
the extent necessary to carry out each Fund’s investment strategies and objectives, may be materially impaired. All of the foregoing could impair a Fund’s ability to maintain operational standards (such as with respect to satisfying
redemption requests), providers, adversely affect the value and liquidity of each Fund’s investments, and negatively impact each Fund’s performance and your investment in the respective associated disruptions could impair the Fund’s
ability to maintain operational standards, disrupt the operations of the Fund’s service providers, adversely affect the value and liquidity of the Fund’s investments, and negatively impact the Fund’s performance and your investment in
the respective Fund.
The Funds are exposed to counterparty risk, or the risk that an institution or other entity with which the Funds have
unsettled or open transactions will default. The potential loss to the Funds could exceed the value of the financial assets recorded in the Funds’ financial statements. Financial assets, which potentially expose the Funds to counterparty risk,
consist principally of cash due from counterparties and investments. The Investment Manager seeks to minimize the Funds’ counterparty risk by performing reviews of each counterparty and by minimizing concentration of counterparty risk by
undertaking transactions with multiple customers and counterparties on recognized and reputable exchanges. Delivery of securities sold is only made once the Funds have received payment. Payment is made on a purchase once the securities have been
delivered by the counterparty. The trade will fail if either party fails to meet its obligation.
The Funds are exposed to risks associated
with leverage. Leverage may cause the value of the Funds’ shares to be more volatile than if the Funds did not use leverage. This is because leverage tends to exaggerate the effect of any increase or decrease in the value of the Funds’
portfolio securities. The Funds may engage in transactions or purchase instruments that give rise to forms of leverage. In addition, to the extent the Funds employ leverage, dividend and interest costs on such leverage may not be recovered by any
appreciation of the securities purchased with the leverage proceeds and could exceed the Funds’ investment returns, resulting in greater losses. As discussed further in Note 7 and Note 8, the Funds have entered into a credit agreement. In
connection with their use of leverage as well as their investment activities, the Funds may have exposure to the LIBOR. LIBOR is an average interest rate, determined by the ICE Benchmark Administration, that banks charge one another for the use of
short-term money. The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, has announced plans to phase out the use of LIBOR by the end of 2021. There remains uncertainty regarding the future utilization of LIBOR and the nature
of any replacement rate, and any potential effects of the transition away from LIBOR on a Fund or on certain instruments in which a Fund invests are not known. As discussed further in Note 7 and Note 8, Diversified Income & Convertible has
mandatory redeemable preferred shares and senior secured notes outstanding and entered into margin loan financing.
The Funds may hold
defaulted securities that may involve special considerations including bankruptcy proceedings, other regulatory and legal restrictions affecting the Funds’ ability to trade, and the availability of prices from independent pricing services or
dealer quotations. Defaulted securities are often illiquid and may not be actively traded. Sale of securities in
69
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
bankrupt companies at an acceptable price may be difficult and differences compared to the value of the securities used by the Funds could be
material. A Fund may incur additional expenses to the extent it is required to seek recovery upon a portfolio security’s default in the payment of principal or interest. In any bankruptcy proceeding relating to a defaulted investment, a Fund
may lose its entire investment or may be required to accept cash or securities with a value substantially less than its original investment.
Diversified Income & Convertible will terminate on the first business day following the fifteenth anniversary of the effective date of its
registration statement, May 22, 2030, unless such term is extended by the Trustees and absent Trustee and shareholder approval to amend the limited term. Leading up to the Fund’s dissolution date, the Fund may begin liquidating all or a
portion of the Fund’s portfolio, and the Fund may deviate from its investment strategy. As a result, during the wind-down period, the Fund’s distributions may decrease, and such distributions may include a return of capital. The Fund does
not seek to return $25.00 per common share (its initial offering price) upon termination. As the assets of the Fund will liquidate in connection with its termination, the Fund may be required to sell portfolio securities when it otherwise would not,
including at times when market conditions are not favorable, which may cause the fund to lose money.
3. Financial Derivative Instruments
Disclosure about derivatives and hedging activities requires qualitative disclosure regarding objectives and strategies for using derivatives,
quantitative disclosure about fair value amounts of gains and losses on derivatives, and disclosure about credit-risk-related contingent features in derivative agreements. The disclosure requirements distinguish between derivatives which are
accounted for as “hedges”, and those that do not qualify for such accounting. Although the Funds at times use derivatives for hedging purposes, the Funds reflect derivatives at fair value and recognizes changes in fair value through the
Fund’s Statements of Operations, and such derivatives do not qualify for hedge accounting treatment.
The Funds may write (sell) put and call options on securities and indices to earn premiums, for hedging purposes, risk management purposes or
otherwise as part of their investment strategies. When an option is written, the premium received is recorded as an asset with an equal liability that is subsequently marked to market to reflect the market value of the option written. These
liabilities, if any, are reflected as options written in the Funds’ Statements of Assets and Liabilities. Premiums received from writing options which expire unexercised are recorded on the expiration date as a realized gain. The difference
between the premium received and the amount paid on effecting a closing purchase transaction, including brokerage commissions, is also treated as a realized gain, or if the premium is less than the amount paid for the closing purchase transaction,
as a realized loss. If a call option written is exercised, the premium is added to the proceeds from the sale of the underlying security in determining whether there has been a realized gain or loss. If a put option written is exercised, the premium
reduces the cost basis of the security. In writing an option, the Funds bear the market risk of an unfavorable change in the price of the security underlying the written option. Exercise of a written option could result in the Funds purchasing a
security at a price different from its current market value.
There are several risks associated with option transactions on securities. For
example, there are significant differences between the securities and options markets that could result
70
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
in an imperfect correlation between these markets, causing a given transaction not to achieve its objective. The Funds’ ability to use options
successfully will depend on the Investment Manager’s ability to predict pertinent market movements, which cannot be assured. As the writer of a covered call option, a Fund foregoes, during the option’s life, the opportunity to profit from
increases in the market value of the security covering the call option above the sum of the premium and the strike price of the call, but has retained the risk of loss should the price of the underlying security decline.
4. Investment Manager & Deferred Compensation
Investment Manager. During the reporting period, each Fund had in place an Investment Management Agreement (for the purpose of this section,
each an “Agreement”) with the Investment Manager. Subject to the supervision of the Funds’ Board, the Investment Manager was responsible for managing the Funds’ investment activities, business affairs and administrative matters.
Pursuant to their Agreements, Diversified Income & Convertible and Equity & Convertible Income paid the Investment Manager an annual fee, payable monthly, at an annual rate of 1.00% of their average daily total managed assets.
Pursuant to its Agreement, Dividend, Interest & Premium Strategy paid the Investment Manager an annual fee, payable monthly, at an annual rate of 0.90% of its average daily total managed assets. Diversified Income &
Convertible’s Agreement defines total managed assets as the total assets of the Fund (including assets attributable to any Preferred Shares, borrowings, issued debt securities or other forms of leverage that may be outstanding) minus accrued
liabilities (other than liabilities representing leverage). The Agreements of each of Dividend, Interest & Premium Strategy and Equity & Convertible Income define total managed assets as the total assets of each Fund (including
assets attributable to any borrowing that may be outstanding) minus accrued liabilities (other than liabilities representing borrowings). Effective February 1, 2021, each Fund entered into new investment advisory agreements with VIA, and VIA,
in turn, entered into subadvisory agreements with AllianzGI U.S. with respect to each Fund and, with respect to NFJ, NFJ Investments. Please see Note 9 for additional information.
Deferred Compensation. The Trustees do not currently receive any pension or retirement benefits from the Trust. In calendar year 2018 and
certain prior periods, the Funds maintained a deferred compensation plan pursuant to which each Independent Trustee had the opportunity to elect not to receive all or a portion of his or her fees from the Fund on a current basis, but instead to
receive in a subsequent period chosen by the Independent Trustee an amount equal to the value of such compensation if such compensation had been invested in one or more series of Virtus Investment Trust (formerly known as Allianz Funds) and Virtus
Strategy Trust (formerly known as Allianz Funds Multi-Strategy Trust) selected by the Independent Trustees from and after the normal payment dates for such compensation. The deferred compensation program was closed to new deferrals effective
January 1, 2019, and all Trustee fees earned with respect to service in calendar year 2019 and 2020 were paid in cash, on a current basis. The Funds still have obligations with respect to Independent Trustee fees deferred in 2018 and in prior
periods, and will continue to have such obligations until all deferred Trustee fees are paid out pursuant to the terms of the deferred compensation plan.
71
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
5. Investments in Securities
For the year ended
January 31, 2021, purchases and sales of investments, other than short-term securities were:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases
|
|
|
Sales
|
|
|
|
|
|
|
Diversified Income & Convertible
|
|
$
|
481,260,153
|
|
|
$
|
493,942,248
|
|
|
|
|
|
|
Equity & Convertible Income
|
|
|
599,923,052
|
|
|
|
660,700,647
|
|
|
|
|
|
|
Dividend, Income & Premium Strategy
|
|
|
1,302,009,339
|
|
|
|
1,400,844,286
|
|
6. Income Tax Information
The tax character of dividends and distributions paid were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended January 31, 2021
|
|
|
Year ended January 31, 2020
|
|
|
|
|
Ordinary
Income(1)
|
|
|
20% Long-
Term
Capital Gain
|
|
|
Return of
Capital
|
|
|
Ordinary
Income(1)
|
|
|
15% Long-
Term
Capital Gain
|
|
|
25% Long-
Term
Capital Gain
|
|
|
|
|
|
|
|
|
|
|
Diversified Income & Convertible
|
|
$
|
24,437,972
|
|
|
$
|
205,911
|
|
|
|
—
|
|
|
$
|
20,701,709
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Equity & Convertible Income
|
|
|
33,603,022
|
|
|
|
8,514,605
|
|
|
|
—
|
|
|
|
24,401,959
|
|
|
$
|
60,919,464
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Dividend, Interest & Premium Strategy
|
|
|
37,593,542
|
|
|
|
20,751,944
|
|
|
$
|
26,975,937
|
|
|
|
39,294,743
|
|
|
|
2,810,828
|
|
|
$
|
12,055
|
|
|
|
(1)
|
Includes short-term capital gains, if any.
|
At January 31, 2021, the components of distributable earnings were as follows.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ordinary Income
|
|
|
20% Long-Term
Capital Gain
|
|
|
Capital Loss
Carryforwards(2)
|
|
|
|
|
|
|
|
Diversified Income & Convertible
|
|
$
|
36,405,983
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
Equity & Convertible Income
|
|
|
32,469,312
|
|
|
|
—
|
|
|
$
|
5,841,063
|
|
|
|
|
|
|
|
Dividend, Interest & Premium Strategy
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(2)
|
Capital loss carryforwards available as a reduction, to the extent provided in the regulations, of any future net
realized gains. To the extent that these losses are used to offset future realized capital gains, such gains will not be disbursed.
|
At January 31, 2021, capital loss carryforward amounts were:
|
|
|
|
|
|
|
|
|
|
|
|
|
No Expiration(3)
|
|
|
|
|
Short-Term
|
|
|
Long-Term
|
|
|
|
|
|
|
Equity & Convertible Income
|
|
|
—
|
|
|
$
|
5,841,063
|
|
|
|
(3)
|
Carryforward amounts are subject to the provision of the Regulated Investment Company Modernization Act of 2010.
|
72
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
For the year ended January 31, 2021, the Funds utilized the following amounts of capital loss carryforwards:
|
|
|
|
|
|
|
|
|
|
|
|
|
Post-Enactment Utilized
|
|
|
|
|
Short-Term
|
|
|
Long-Term
|
|
|
|
|
|
|
Equity & Convertible Income
|
|
|
—
|
|
|
$
|
4,117,651
|
|
For the year ended January 31, 2021, permanent “book-tax” adjustments were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Undistributed
(dividends in excess
of) net investment
income
|
|
|
Accumulated
net realized
gain (loss)
|
|
|
Paid-in
Capital In
Excess of
Par
|
|
|
Unrealized
Appreciation
(Depreciation)
|
|
|
|
|
|
|
|
|
Diversified Income & Convertible(a)(c)(d)(e)(g)
|
|
$
|
1,223,690
|
|
|
$
|
(1,060,679
|
)
|
|
$
|
(155,959
|
)
|
|
$
|
(7,052
|
)
|
|
|
|
|
|
|
|
Equity & Convertible Income(a)(c)(d)
|
|
|
497,580
|
|
|
|
(456,059
|
)
|
|
|
—
|
|
|
|
(41,521
|
)
|
|
|
|
|
|
|
|
Dividend, Interest & Premium Strategy(a)(b)(c)(d)(f)
|
|
|
1,433,366
|
|
|
|
(1,237,513
|
)
|
|
|
(981
|
)
|
|
|
(194,872
|
)
|
These permanent “book-tax” differences were primarily
attributable to:
|
|
(a)
|
Reclassification of contingent debt
|
|
|
(b)
|
Reclassification from sales of securities with return of capital
|
|
|
(c)
|
Reclassifications related to investments in Real Estate Investment Trusts (REITs)
|
|
|
(d)
|
Section 305 sales adjustment
|
|
|
(e)
|
Non-deductible excise tax
|
|
|
(f)
|
Reclassification due to investments in partnerships
|
|
|
(g)
|
Treatment of bond premium amortization
|
Net investment income, net realized gains or losses and net assets were not affected by these adjustments.
At January 31, 2021, the aggregate cost basis and the net unrealized appreciation (depreciation) of investments for federal income tax
purposes were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal Tax
Cost Basis(4)
|
|
|
Unrealized
Appreciation
|
|
|
Unrealized
Deprecation
|
|
|
Net Unrealized
Appreciation
(Depreciation)
|
|
|
|
|
|
|
|
|
Diversified Income & Convertible
|
|
$
|
396,418,655
|
|
|
$
|
86,981,388
|
|
|
$
|
9,522,084
|
|
|
$
|
77,459,304
|
|
|
|
|
|
|
|
|
Equity & Convertible Income
|
|
|
695,405,058
|
|
|
|
168,756,723
|
|
|
|
7,937,035
|
|
|
|
160,819,688
|
|
|
|
|
|
|
|
|
Dividend, Interest & Premium Strategy
|
|
|
1,262,807,523
|
|
|
|
213,192,536
|
|
|
|
44,985,510
|
|
|
|
168,207,026
|
|
|
|
(4)
|
Differences between book and tax cost basis are primarily attributable to the differing treatment of convertible
securities, wash sale loss deferrals, Section 305 adjustments, basis adjustments from investments in partnerships, and differing treatment of bond premium amortization.
|
7. Long-Term Financing Arrangements
On
October 2, 2015, Diversified Income & Convertible completed a private placement with a single institutional investor, consisting of $30,000,000 in Series A Mandatory Redeemable Preferred Shares (“MRPS”) with a mandatory
redemption date of October 2, 2025, and $50,000,000 in Senior Secured Notes (“Notes” and together with MRPS, “Long-Term
73
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
Financing Arrangements”) due November 22, 2029. Fitch Ratings (“Fitch”) assigned a rating of “AA” to the MRPS and
“AAA” to the Notes. On May 14, 2020, Fitch downgraded the ratings assigned to the senior secured notes to AA and placed the notes on Rating Watch Negative (“RWN”). On the same date, the MRPS were placed on RWN. The Long-Term
Financing Arrangements refinanced a portion of the Diversified Income & Convertible’s short-term borrowings under the Margin Loan Financing described in Note 8. For a portion of its borrowings, Diversified Income & Convertible
continues to maintain short-term borrowings under the Margin Loan Financing described in Note 8 at variable interest rates.
|
|
Mandatory
|
Redeemable Preferred Shares
|
At January 31, 2021, Diversified Income & Convertible had 1,200,000 shares of MRPS outstanding with an aggregate liquidation
preference of $30,000,000 ($25.00 per share). The following table summarizes the key terms of the MRPS at January 31, 2021:
|
|
|
|
|
|
|
|
|
Mandatory
Redemption
Date
|
|
Annual
Dividend
Rate
|
|
Aggregate
Liquidation
Preference
|
|
Estimated
Fair Value
|
October 2,
2025
|
|
4.34%
|
|
$30,000,000
|
|
$30,000,000
|
The fair value of the MRPS are estimated to be their liquidation preference. The MRPS are categorized as Level 2
within the fair value hierarchy. Holders of MRPS are entitled to receive a quarterly dividend at an annual fixed dividend rate of 4.34%, subject to upward adjustment (by as much as 4.00%) during any period when the MRPS have a rating of below
“A” from Fitch, or the equivalent from another rating agency (with the rate increasing at lower rating levels). The MRPS will have a “default” rate of 5.00% whenever a past due amount is outstanding with respect to the MRPS.
Dividends are accrued daily and paid quarterly and are presented in Diversified Income & Convertible’s Statement of Assets & Liabilities as interest payable on mandatory redeemable preferred shares. For the year ended
January 31, 2021, Diversified Income & Convertible paid $1,302,000 in dividends to mandatory redeemable preferred shareholders. The MRPS are senior, with priority in all respects, to Diversified Income & Convertible’s
outstanding common shares as to payments of dividends and as to distribution of assets upon dissolution, liquidation or winding up of the affairs of the Fund. The MRPS rank pari passu with any and all other preferred shares of the Fund, and rank
junior to the Fund’s indebtedness, including the Notes, the Margin Loan Financing and any other senior secured indebtedness. Diversified Income & Convertible may redeem all or any part of the MRPS at any time, subject to certain
redemption premiums. With respect to the MRPS, the Fund is subject to periodic asset coverage testing. If the Fund’s asset coverage is insufficient, it may be required to redeem some or all of the MRPS. No such mandatory redemption had been
triggered as of the end of the most recent fiscal period.
At January 31, 2021, Diversified Income & Convertible had $50,000,000 in aggregate principal amount of Notes outstanding. The Notes
rank pari passu with all other senior debt of Diversified Income & Convertible, including the Margin Loan Financing, and are secured by a lien on all assets of the Fund of every kind, including all securities and all other investment
property, equal and ratable with the liens securing the Margin Loan Financing. The Notes are senior, with priority in all respects, to the MRPS and the outstanding common
74
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
shares as to payments of dividends and as to distribution of assets upon dissolution, liquidation or winding up of the affairs of the Fund. Holders
of the Notes are entitled to receive cash interest payments semi-annually until maturity. The Notes accrue interest at an annual fixed rate of 3.94%. The Notes will be subject to a penalty interest rate of an additional 2.00% while overdue payments
are outstanding, and an additional 1.00% during any interest rate period when the Notes, at any time, have a rating of less than “A-” from Fitch or the equivalent from another agency. The Notes are
prepayable in whole or in part at any time, subject to a prepayment premium, which may be adjusted under some circumstances based on asset coverage levels. Interest expense of $1,975,397 is included in the Diversified Income &
Convertible’s Statement of Operations.
The following table shows the maturity date, interest rate, notional/carrying amount and estimated
fair value of the Notes outstanding at January 31, 2021:
|
|
|
|
|
|
|
|
|
Maturity Date
|
|
Interest
Rate
|
|
Notional/
Carrying
Amount
|
|
Estimated
Fair Value
|
|
November 22, 2029
|
|
3.94%
|
|
$50,000,000
|
|
$50,000,000
|
The fair value of the senior secured notes are estimated to be their carrying amount. The senior secured notes are
categorized as Level 2 within the fair value hierarchy.
With respect to the Notes, the Fund is subject to monthly asset coverage tests that
mirror those applicable to closed-end funds set forth in Section 18 of the 1940 Act, as well as periodic asset coverage tests that are tied to rating agency criteria, in each case subject to various terms
and conditions. A breach of any of these tests, after the passage of a cure period, would constitute an event of default under the Notes. As of the end of the most recent fiscal period, no such breach had occurred. The agreements governing the MRPS
and Notes impose certain additional customary covenants and restrictions on the Fund, including, among others, restrictions on distributions and a requirement that the Fund adhere to its stated investment policies.
8. Margin Loan Financing
Diversified
Income & Convertible has entered into a margin loan financing agreement with BNP Paribas Prime Brokerage International, Ltd. (“BNP”). The margin loan is offered at a daily rate equal to the U.S.
3-month LIBOR rate plus 0.90%. At January 31, 2021, the Fund had a borrowing outstanding under the margin agreement totaling $25,000,000. The interest rates charged at January 31, 2021, was 1.100%.
During the year ended January 31, 2021, the weighted average daily balance outstanding was $25,000,000 at the weighted average interest rate of 1.417%. With respect to the margin loan financing, loan interest expense of $324,262 is included in
the Diversified Income & Convertible’s Statement of Operations. The Fund is required to fully collateralize its outstanding loan balance as determined by BNP. Pledged assets are held in the Fund’s custody account and are denoted
in the Fund’s Schedule of Investments.
9. Subsequent Events
In preparing these financial statements, the Funds’ management has evaluated events and transactions for potential recognition or disclosure
through the date the financial statements were issued.
75
NOTES TO FINANCIAL STATEMENTS (Continued)
JANUARY 31, 2021
Transition:
Effective
February 1, 2021, following shareholder approval of new investment advisory agrements, VIA or an affiliate of VIA became the investment adviser and administrator to the Funds upon the closing of the Transition. AllianzGI U.S. became the sole sub-adviser to Diversified Income & Convertible and Equity & Convertible Income, while AllianzGI U.S. and NFJ Investments became sub-advisers to Dividend,
Interest & Premium Strategy. NFJ Investments is a newly organized, wholly owned subsidiary of Virtus.
On the effective date of the
transition, VIA has contractually agreed to limit each Fund’s annual total operating expenses, subject to the exceptions listed below, so that such expenses do not exceed, on an annualized basis, the following respective percentages of average
daily net assets through February 1, 2023. Following the contractual period, VIA may discontinue these expense reimbursement arrangements at any time. The reimbursements are calculated daily and received monthly.
|
|
|
|
|
|
|
Fund Name
|
|
Expense Limit
|
|
|
|
|
|
Diversified Income & Convertible
|
|
|
0.17
|
%
|
|
|
|
|
Equity & Convertible Income
|
|
|
0.07
|
%
|
|
|
|
|
Dividend, Interest & Premium Strategy
|
|
|
0.06
|
%
|
The exceptions include investment advisory fees paid to VIA, interest, any other fees or expenses relating to
financial leverage, preferred shares or borrowings, taxes, extraordinary, unusual or infrequently occurring expenses, costs related to share offerings, brokerage commissions, expenses incurred in connection with any merger or reorganization,
underlying fund expenses and dividend expenses, if any.
Also on the effective date of the transition, the Funds’ adopted an amended
valuation policy, which changes the pricing methodology for debt instruments and options.
Distributions:
On February 1, 2021, a monthly distribution of $0.167 per share was declared to Diversified Income & Convertible common shareholders,
payable March 1, 2021 to common shareholders of record on February 11, 2021.
On March 1, 2021, a monthly distribution of $0.167
per share was declared to Diversified Income & Convertible common shareholders, payable April 1, 2021 to common shareholders of record on March 11, 2021.
On March 5, 2021, the following quarterly distributions were declared to shareholders, payable March 26, 2021 to shareholders of record
on March 15, 2021:
Equity & Convertible Income $0.38 per share
Dividend, Interest & Premium Strategy $0.225 per share
Changes to the Board of Trustees:
Effective February 1, 2021, (i) Erick R. Holt resigned his position as a Trustee of the Funds, (ii) George R. Aylward and Philip
McLoughlin became Trustees of the Funds, and (iii) Brian T. Zino became an advisory Trustee of each Fund.
76
Report of Independent Registered Public
Accounting Firm
To the Board of Trustees and
Shareholders of Virtus AllianzGI Diversified Income & Convertible Fund, Virtus AllianzGI Equity & Convertible Income Fund, and Virtus Dividend, Interest & Premium Strategy Fund