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Highland Global Allocation Fund Failed Shareholders

The fund loaded-up on private equity and debt, then had to convert into a closed-end fund amid a liquidity crunch.

Executive Summary
Highland Capital Management, which manages Highland Global Allocation (HGLB), misstated the value of one of the fund's largest holdings, TerreStar, last year. That error threw off the calculation of the fund's net asset value and, therefore, the performance the fund reported to shareholders. Nevertheless, it doesn't appear Highland corrected the misstatements in a timely manner--it continued to publish the same erroneous historical NAVs and to advertise returns derived from those NAVs.

Beyond the restatement, there's reason to question Highland's valuation of TerreStar, a privately held licensee of wireless spectrum capacity. Highland appears to have valued the firm as if it's a stable going concern. Yet TerreStar has no sales, profits, or cash flows, and one of the two spectrum bands it licensed was terminated by the Federal Communications Commission in 2017. Highland appears to have used questionable assumptions and inputs to justify its valuation of TerreStar, which recently accounted for more than 15% of the fund's assets.

Taken together with other issues at the fund, which Highland recently converted from an open-end to a closed-end structure after the portfolio became too illiquid, this episode raises serious concerns about Highland's commitment to shareholders, the strength of its internal controls and risk-management practices, and the fund board's diligence in overseeing Highland.

Background
Highland Global Allocation is in the world-allocation Morningstar Category, which means it spreads its investments across a variety of asset classes and geographic locales. Even by the category's standards, Highland Global Allocation's strategy is freewheeling: It invests long and short across the capital spectrum, employs leverage, and concentrates its positions. For instance, the fund's top holding,  Vistra Energy (VST), recently accounted for almost a third of its net assets.

That daring approach has boosted the fund's performance at times but has also given it a very aggressive risk profile; in fact, the fund has been much more volatile than its average peer and even pure equity benchmarks like the S&P 500 and MSCI All-Country World Index, while producing unremarkable returns. Consequently, its risk-adjusted performance has badly lagged.


  - source: Morningstar Analysts

Note: "Highland Global Allocation" = NAV return of Highland Global Allocation Y shares from strategy inception date of April 9, 2013, through Feb. 14, 2019, and NAV return of Highland Global Allocation closed-end fund (HGLB) from Feb. 15, 2019, through May 10, 2019; "U.S. Stocks" = S&P 500 TR USD; "Global Stocks" = MSCI ACWI NR USD Index; "World Alloc. Cat. Avg." = U.S. world-allocation category average return from April 9, 2013, through Feb. 14, 2019, and U.S. CEF world-allocation category average return from Feb. 15, 2019, through May 10, 2019; "Global Bonds" = Bloomberg Barclays Multiverse TR USD Index; "U.S. Bonds" = Bloomberg Barclays U.S. Universal TR USD Index. Source: Morningstar Direct

That doesn't tell the whole story, though. The fund has routinely taken large stakes in illiquid, hard-to-value securities. In fact, these securities--known in accounting parlance as "Level 3" instruments--recently soaked up more than 20% of the fund's net assets.[1] Because these investments don't usually trade or have readily ascertainable prices, their valuation is subject to management's judgment.[2] Consequently, Highland has been valuing large swaths of the portfolio based on its own estimates and assumptions.


Source: Highland Global Allocation periodic SEC filings, Morningstar calculations

TerreStar Corporation
One of the illiquid securities Highland was attempting to value in this fashion was the common stock of a firm named TerreStar Corporation. TerreStar is a privately held licensee of wireless spectrum capacity. Here's how Highland described TerreStar in the fund's most-recent annual report:

"TerreStar is a non-operating company that does not currently generate revenue and which primarily derives its value from two spectrum frequencies, the license with respect to one of which was terminated by the FCC and is being contested by TerreStar on technical and public policy grounds. TerreStar currently anticipates such contest may take between 12 to 30 months and expects deployment of its other spectrum asset to require a similar period of time. If TerreStar is ultimately unsuccessful in its efforts, the terminated license would not be reinstated and the value of the TerreStar equity would likely be materially negatively impacted."

Source: Highland Global Allocation Fund annual report for fiscal year ended Sept. 30, 2018; footnote 8, "Disclosure of Significant Risks and Contingencies"

TerreStar is significant to the fund for a few reasons. First, it became a big position over time, as shown in Exhibit 3.


Source: Morningstar Direct

Second, Highland misvalued its TerreStar equity investment.

"Subsequent to September 30, 2018, it was determined that the valuation of the Fund's investment in equity issued by TerreStar Corporation was incorrect during a period beginning in March 2018 through at least September 30, 2018. The reduction in value of the position as included in these financial statements from the final daily net asset value struck in September 2018 was approximately $14.4 million."

Source: Highland Global Allocation Fund annual report for fiscal year ended Sept. 30, 2018; footnote 7, "Advisory, Administration, Service and Distribution, Trustee, and Other Fees"

This news didn't come out of the blue. Highland had previously disclosed a disagreement with its auditor, KPMG, over the valuation of TerreStar equity. That disagreement, which centered on which inputs to use in valuing TerreStar, led to KPMG's dismissal on Sept. 28, 2018, and a delay in filing the fund's annual report.

KPMG's replacement, PriceWaterhouseCoopers, subsequently concluded that Highland had erred. In addition, Highland's CEO and CFO reported that the fund's controls and procedures were not effective "due to a material weakness" and that this weakness had resulted in "material pricing errors" that the $14.4 million restatement aimed to rectify.

(For further background on the TerreStar revaluation, see "When Mutual Fund Values Get Muddy" and "When Investing on Auto-pilot Isn't Enough", by Jason Zweig of the Wall Street Journal.)

Corrected?
Highland does, in fact, seem to have corrected the error in the fund's annual report.[3] The TerreStar equity position was marked down and, further, the fund set up a receivable to account for over-redemptions (resulting from the fund cashing out shareholders at the inflated NAV) and a payable for share underissuances (stemming from the fund buying shareholders in at the overstated NAV).[4] It appears that Highland repaid the fund's receivable out-of-pocket in February 2019.

But that doesn't mean the situation was fixed where shareholders are concerned. Indeed, it does not appear that Highland corrected the NAVs it published for the fund over the six months ended Sept. 30, 2018. If that's so, then it would also mean the fund's performance wasn't restated to reflect the $14.4 million write-down in a timely way.

We infer this from the fact that Morningstar never received instructions to correct the NAVs and the returns we derived from the unrestated NAVs on file match those reported by Highland. This wouldn't be possible if Highland had restated the returns to reflect restated NAVs.

To illustrate, as recently as March 29, 2019, one could find the following presentation of the fund's trailing returns on Highland funds' website. These figures match the returns we have on record for the fund for the relevant trailing periods ended Dec. 31, 2018.


Source: Highland funds website

We have submitted multiple requests to Highland and the fund's then-custodian, State Street, for corrected NAVs. A State Street representative confirmed the firm had not sent Morningstar any NAV revisions before referring us to Highland.

Through a spokesperson, Highland stated that the fund's NAV had been corrected on Jan. 28, 2019. However, the firm could not furnish restated historical NAVs before disclosing them to shareholders, as the restated NAVs are "material nonpublic information."[5]

At a minimum, Highland is likely to owe the fund additional sums to compensate it for overpayments of redeeming shareholders who were cashed out at inflated NAVs subsequent to Sept. 30, 2018, as disclosed in the fund's annual report:

"The Adviser expects that there will be additional amounts owed to the Fund subsequent to September 30, 2018 related to the change of inputs used in the valuation of TerreStar Corporation."

Highland Global Allocation Fund annual report dated Sept. 30, 2018, note 7, "Advisory, Administration, Service and Distribution, Trustee, and Other Fees/Due from Investment Adviser."

TerreStar Valuation
These accounting corrections aside, there's the larger question of whether Highland's revised TerreStar valuation should be relied upon. It's not a small matter, considering that the fund's TerreStar equity investment recently totaled around $48 million, or more than 15% of the fund's assets.[6]

To put the fund's TerreStar valuation in broader context, it's useful to examine a time lapse of the marks that Highland has placed on TerreStar since November 2014, when the fund began building its stake.


Source: Highland Global Allocation Fund periodic SEC filings; Morningstar Direct

The chart is most striking for what it lacks: volatility. Highland's TerreStar valuation has been narrowly range-bound for most of the time the fund has owned it. Highland even touted the TerreStar equity investment's mild risk profile on two separate occasions, boasting that the position exhibited "very little volatility" in its 2016 and 2017 annual reports.

That's remarkable considering the nascent state of TerreStar's business. The firm has no sales, profits, or cash flows. It's also not clear whether a market for its assets--the two wireless spectrum bands it licenses from the FCC--will form. TerreStar's claim to those assets is in dispute. In October 2017, the FCC terminated one of the two licenses that TerreStar held. Though TerreStar is contesting this decision and Highland has expressed confidence that contest will succeed, it casts further doubt on the viability of its business.

That's not discernible from Highland's TerreStar marks, though. If anything, the TerreStar position has traded more like a bond than an equity stake in a risky venture with a wide range of potential future outcomes--one of them being worthlessness. At times, the valuation has seemed to defy logic altogether, with Highland originally marking up its TerreStar position in late-2018, after the FCC decision to terminate its spectrum license to the 1.4 GHz band. (Those markups were undone when the TerreStar position was later revalued.)

The Inputs
Highland has used a somewhat changing assortment of inputs to value TerreStar, but it appears two main types of assumptions drove its estimates: recent transactions and fundamental inputs.

Recent Transactions
One key input into Highland's TerreStar valuation has been recent transactions in TerreStar shares. In an August 2018 proxy filing (to convert Highland Global Allocation from an open-end to a closed-end fund), Highland laid out a chronology of recent buys and sells in TerreStar stock. Interestingly, Highland incorporated only one of the three trades mentioned--a July 2018 transaction at $350 per share--into its valuation, which was $334 per share at the time. Highland excluded the other two trades from its valuation--both in March 2018 at $114 per share--because in its opinion they were "not orderly."

But it's evident that Highland affiliates were party to at least one of the two excluded transactions. Indeed, filings show that in March 2018 two Highland-managed CEFs--Highland Floating Rate Opportunities and NexPoint Strategic Opportunities--bought 27,134 and 21,929 shares of TerreStar stock, respectively, at $114 per share. In addition, another Highland affiliate, business development company NexPoint Capital, bought 14,035 shares at $114 per share.[7] These funds promptly marked up their TerreStar position to around $279 per share.

(The fund's previous auditor, KPMG, disagreed with excluding these two transactions; their replacement, PriceWaterhouseCoopers, ultimately concluded they were orderly and therefore should be incorporated into Highland's TerreStar valuation, as further detailed in this filing.)

This would seem to put Highland in the incongruous position of arguing to both incorporate and ignore recent transaction history when valuing TerreStar. For if recent transactions were a guide to TerreStar's fair value, then Highland arguably ought to have impounded the $114-per-share transactions into its valuation, making it more difficult to promptly mark up the position. Instead, it appears Highland chose to disregard these transactions in favor of those that supported a higher fair value. In responding to questions about this practice, a Highland spokesperson asserted that "buying an asset at a low price and selling it at a high price is effective management."

The lone transaction Highland chose to incorporate was the fund's July 2018 sale of 71,428 TerreStar shares at $350 per share[8] to an entity it described as a "sophisticated institutional investor and existing TerreStar shareholder."

When asked, Highland declined to name the buyer of those shares or to identify the buyer of an additional 65,591 TerreStar shares the fund sold for the same price in December 2018.

The Highland spokesperson did not respond to questions into what percentage of TerreStar's outstanding shares Highland and its affiliates owned as of March 2018, July 2018, and December 2018, and whether that ownership conferred the same proportionate control of TerreStar.

Fundamental Inputs
A time-lapse of the fundamental inputs disclosed in the fund's periodic filings is shown in Exhibit 6.


Source: Highland Global Allocation periodic filings

Of these inputs, the one that seems to carry the most weight by far is "price per megahertz pop" (Price/MHz-PoP). Hertz is a measure of radio wave frequencies, 1 megahertz (MHz) equaling 1 million hertz. "Megahertz pop" expresses the amount of frequency passing through populated areas (PoP). For instance, if 4 MHz of frequency reach a coverage area of 2 million people, this equates to 8 million MHz-Pop. Price/MHz-PoP puts a dollar value on frequency coverage.

In general, as the midpoint of Highland's assumed Price/MHz-PoP range moved higher, so too did the value it placed on TerreStar and vice versa. For instance, Highland's estimated TerreStar valuation leapt around 19% (to $333.62 per share from $261.83 per share) between June 30, 2018, and Sept. 30, 2018, when it raised the top end of the Price/MHz-PoP range to $0.675 from $0.55. (Highland's recent restatement of TerreStar's valuation partially rolls back these markups; a Highland spokesperson did not respond to a request to specify the Price/MHz-PoP assumption it had assigned to each of the two licenses.)

It's highly debatable whether this assumed Price/MHz-PoP range is appropriate for the licenses concerned. The FCC terminated TerreStar's spectrum license to the 1.4 GHz band, rendering it unusable pending TerreStar's efforts to get it reinstated. Highland expects that process--which has included sustained legal advocacy with the FCC, a public outreach campaign, and what appears to be a coordinated lobbying push--to take 12-30 months to complete (from the time of the FCC's October 2017 ruling).

If TerreStar succeeds in its contest, it still presumably must raise capital for its revised plan to deploy the spectrum for use by wireless medical telemetry service devices, or WMTS, which it expects to culminate in a "full-scale deployment" at 2,000 healthcare facilities in April 2020. It's noteworthy that the FCC, in explaining its rationale for refusing to allow TerreStar to continue to license the 1.4 GHz band, questioned whether additional WMTS spectrum capacity was even needed.[9]

For the moment, that leaves TerreStar with just one usable license, this one to spectrum in the 1.7 GHz band that it acquired through an entity named "2014 AWS Spectrum Bidco" in 2015 for around $292 million, or $0.50/MHz-PoP. The 18 spectrum blocks TerreStar obtained at auction, shown in Exhibit 7, are "unpaired," meaning they can uplink to a wireless tower but not downlink to devices. (There were no downlink blocks offered in the 1700-1710 MHz frequency TerreStar obtained the licenses in.)


Source: FCC AWS-3 Auction Winning Bids (Attachment A) dated Jan. 29, 2015

The fact that the blocks are unpaired would seem to limit the market of potential commercial buyers for the capacity. Indeed,  Verizon Communications (VZ), in commenting on the FCC's proposed auction plan, sharply questioned the wisdom of auctioning unpaired spectrum at all, calling it "virtually useless."[10]

Among the potential acquirers of TerreStar's spectrum,  DISH Network (DISH) is by far the most logical candidate, as it occupies the same "B1" spectrum band. Were it to acquire TerreStar's licenses, Dish could fill in a handful of geographic holes, like Washington, D.C., Miami, and Minneapolis, in its otherwise comprehensive position across the major U.S. markets. In addition, a Highland spokesperson asserted that Dish has made progress in achieving interoperability between the 2.0 GHz spectrum it licenses and the uplink blocks TerreStar obtained.

Yet this seems to only reinforce the sense that the market for TerreStar's spectrum is very narrow, with Dish viewed as the primary suitor. However, a Dish bid seems unlikely given that the firm had passed on these licenses once before.[11]

While Dish's business is far more established than TerreStar's given its satellite television franchise, it seems reasonable to assume investors ascribe at least part of Dish's value to its diverse roster of spectrum assets (none of which have been terminated by the FCC). That makes the sharp descent in Dish's stock price since 2014--it had fallen around 57% through March 31, 2019--all the harder to reconcile with Highland's TerreStar valuation, which has stayed on a more-or-less steady trajectory over that time.


Source: Highland Global Allocation periodic SEC filings; Morningstar Direct; quarterly prices only; Dec. 31, 2014-March 31, 2019

A Highland spokesperson stated that TerreStar "has always been fair valued by an independent third-party valuation expert using whatever inputs such expert deemed necessary." The spokesperson did not respond to a question regarding the identity of the valuation expert, but a recent filing indicates IHS Markit, ICE Data Services, and Thomson Reuters recently provided pricing services to the fund.

The Market View
In February 2019, Highland converted Highland Global Allocation from an open-end fund to a CEF. It was forced to take this unusual step because the fund had become too concentrated in illiquid securities like TerreStar to meet purchase and redemption requests in the normal course of operations.[12] Converting to a CEF, Highland argued, would allow it to retain these illiquid names while obviating the need to manage investor cash flows.

Illiquid assets currently constitute approximately 33% of Fund assets (substantially all of which is TerreStar Corporation ("TerreStar") equity and debt) due to historical fund outflows, related sales of liquid assets and, to a lesser extent, illiquid asset appreciation. The closed-end structure would enable the Fund to continue to hold TerreStar, which has been a steadily increasing portion of the portfolio for over two years. A closed-end structure eliminates the Open-End Liquidity Constraints (as defined in the proxy statement), and thus avoids the need to sell investments based on investor flows.

Source: Highland Global Allocation Fund definitive proxy statement dated Oct. 11, 2018, "Summary of Principal Terms and Risks"

To bolster its case, Highland offered shareholders an extra inducement: a "consent fee" equal to 3% of the value of each shareholder's fund holdings provided the shareholder approved the proposal and held on through the conversion. Ultimately, after Highland sweetened the terms of the consent-fee offer to expand eligibility, shareholders approved the conversion proposal. (Highland has paid these shareholders approximately $5 million in consent fees in total, though they netted less than that given the fund also incurred $1.5 million in conversion costs.)

But the conversion didn't mitigate the fund's valuation risk so much as shift it. When Highland Global Allocation was an open-end fund, Highland could manage its valuation risk to a degree through its TerreStar marks. Yet the conversion to a CEF would give the market a say over what the portfolio, including TerreStar, was worth. The CEF's market price--which could be higher (premium) or lower (discount) than its NAV--would ostensibly express that view.

Highland Global Allocation gapped to a sizable discount to NAV soon after converting to a CEF, as shown in Exhibit 9.


Source: Morningstar Direct

The fund's 15.90% discount as of May 10, 2019, was nearly 4 times the average for other world-allocation CEFs. In fact, it was the 11th widest discount of the 493 CEFs that Morningstar tracked as of that date. This is notwithstanding Highland's publicized efforts to narrow the discount, including its commitment to buy shares on the open market and to repurchase shares with fund assets.

Consequently, the CEF has skidded to a roughly 17.5% market loss since debuting in February 2019.


Note: Based on fund's market return. Source: Morningstar Direct

Highland Failed Shareholders

Highland failed shareholders in several ways.

Highland heavily invested the fund's assets in illiquid, hard-to-value securities. An open-end fund demands daily liquidity and price transparency to function, however. This mismatch between the fund's illiquid holdings and the open-end structure was entirely preventable. Yet Highland allowed it to happen and then grossly misjudged the fund's deteriorating liquidity profile until it was too late, forcing it to convert the fund to a closed-end structure.[13]

Highland failed to maintain adequate procedures and controls for valuing the illiquid securities it took positions in. What's more, Highland has not restated the fund's NAV history and reported performance in a timely manner. Shareholders should be able to trust the accuracy of a fund's stated NAV and returns without question. Through these failures, Highland appears to have violated that trust.

Highland appears to have made highly questionable assumptions in valuing TerreStar, even after the restatement. While the CEF's market price already seems to be casting doubt on the portfolio's NAV, that doesn't excuse Highland from incorporating timely, realistic assumptions into its TerreStar valuation. Until that happens, the fund's NAV probably shouldn't be relied upon.

Notwithstanding that, the fund's TerreStar investments appear to have performed poorly. From November 2014, when the fund took its original TerreStar equity position, to December 2018, the fund appears to have realized roughly $8.7 million in gains from shares it sold versus about $20.5 million in unrealized losses on its remaining holdings. It isn't evident that the fund has earned a return thus far from its investment in TerreStar senior debt over that same period, as it's unclear whether the fund was paid any cash interest: The debt was structured as a "payment-in-kind" loan soon after the fund initiated its stake. It sold $40 million of that debt in 2018, realizing a small loss in the process. Debt-in-kind receipts appear to account for the bulk of the fund's remaining position as of December 2018.[14]

Highland received nearly $9.4 million in investment advisory fees from Highland Global Allocation for the fiscal years 2016 through 2018.[15] (The firm does appear to have set aside monies to compensate fund investors for overcharges stemming from levying the fund's expense ratio on its overstated asset base.)

The Fund's Board Failed Shareholders
The fund's board also failed shareholders.

It's the board's responsibility to look out for shareholders' interests by conducting appropriate oversight of Highland. Yet, Highland so mismanaged the fund that it couldn't remain an open-end vehicle, and doubts have arisen over the accuracy of the NAVs and performance it has published. Further, the fund has been forced to restate its financial statements over errors stemming from the way Highland valued TerreStar amid lax internal controls. Fundamental breakdowns like these call the board's diligence into question.

The board also appears to have entanglements with Highland or its affiliates. For instance, Highland's filings indicate that independent Highland funds trustee John Honis is an "indirect" beneficiary of another Highland affiliate:

Since May 1, 2015, Mr. Honis has been treated as an Independent Trustee of the Trust. Prior to that date, Mr. Honis was treated as an Interested Trustee because he was a partner of an investment adviser affiliated with the Adviser until his resignation in November 2014. As of March 5, 2019, Mr. Honis was entitled to receive aggregate severance and/or deferred compensation payments of approximately $400,000 from another affiliate of the Adviser.

In addition, Mr. Honis serves as a trustee of a trust that owns substantially all of the economic interest in an investment adviser affiliated with the Adviser. Mr. Honis indirectly receives an asset-based fee in respect of such interest, which is projected to range from $450,000-$550,000 annually.

Source: Highland Global Allocation Fund registration statement dated March 6, 2019; "Management of the Fund"

Another trustee, Ethan Powell, was a Highland employee until December 2015, including "past service as an officer of funds in the Highland Fund Complex."

Director of equity research media & telecom, Michael Hodel, CFA, contributed to this report.

 

[1]This figure excludes the fund's indirect proportionate ownership of Level 3 securities held by affiliated Highland entities in which the fund has taken a stake. For example, as of Dec. 31, 2018, the fund held a 2.1% position in NexPoint Strategic Opportunities, a CEF that Highland manages. The NexPoint fund had invested roughly half its assets in Level 3 securities as of that date, including around $57 million in TerreStar common stock and senior debt. Thus, Highland Global Allocation's effective Level 3 exposure is slightly higher than the figures cited above. (Highland Global Allocation has often taken large stakes in other Highland and NexPoint funds. As of Dec. 31, 2018, these investments accounted for more than $30 million of the fund's assets. In September 2018, a Highland Global Allocation shareholder brought a shareholder derivative suit against the fund, its board, and Highland for breach of fiduciary duty stemming from the fund's investment in Highland Energy MLP (HEFYX). (Lanotte v. Highland Global Allocation Fund et al, 3:18-cv-02360, U.S. District Court for the Northern District of Texas (Dallas).) As of Dec. 31, 2018, Highland Global Allocation's $11.4 million investment in Highland Energy MLP accounted for nearly 62% of the MLP fund's net assets. The fund, board, and Highland have stated that they believe the claims made in the suit are meritless and intend to vigorously defend against them.)

[2]It is technically the fund board's responsibility to determine the fair value of fund portfolio securities for which market quotations are not readily available. The board does so via a fair value methodology that it approves. However, the board can appoint others, including the fund's manager, to assist in determining fair value and making the actual calculations under that fair value methodology (Source: https://www.sec.gov/rules/final/2014/33-9616.pdf). From all available evidence, it appears Highland played a pivotal role in the process by which TerreStar's valuation was determined, under the board's supervision. Thus, this piece attributes valuation decisions to Highland, while noting that the board has responsibility for conducting appropriate oversight of the fair-valuation process.

[3]Prior to the restatement, Highland had placed a market value of $78,441,402 on the fund's 235,122 TerreStar shares. Following the restatement, Highland valued those same shares at $64,277,652. Source: Morningstar data and Highland Global Allocation annual report dated Sept. 30, 2018.

[4]See Highland Global Allocation annual report dated Sept. 30, 2018, note 7, "Advisory, Administration, Service and Distribution, Trustee, and Other Fees/Due from Investment Adviser"; see also "Response to SEC Staff Letter Dated October 4, 2018--Highland Global Allocation Fund," dated Feb. 13, 2019.

[5]In an October 2016 enforcement action, the SEC found Calvert Investment Management had failed to precisely calculate fund and shareholder losses stemming from a NAV misstatement. However, the SEC's action related to how Calvert had calculated make-whole payments to affected shareholders, not to how Calvert had recalculated the funds' NAVs.

[6]In addition to its stake in TerreStar common equity, Highland Global Allocation also owns a slug of TerreStar senior debt. As of Feb. 28, 2019, the fund valued its TerreStar senior loans at $13.4 million, or around 3.9% of net assets. That's down sharply from last year, when at its peak the fund's TerreStar senior debt position accounted for nearly 10% of the fund's assets. Per the definitive proxy Highland filed to convert the fund from an open-end to a closed-end structure, Highland entered into a binding agreement with an unidentified party to sell as much as its entire TerreStar debt position at then fair value "subject to certain NAV thresholds being reached." It appears the fund sold roughly $40 million in TerreStar senior loans in October and November 2018 per this agreement. When asked, Highland declined to specify the nature or type of NAV thresholds in question or to identify the other party to the sale agreement.

[7]The "summary of changes in the Fund's assets measured at fair value using significant unobservable inputs (Level 3)" table in the footnotes of Highland Floating Rate Opportunity's form N-Q dated March 31, 2018 shows that the fund purchased TerreStar shares at a net cost of $3.1 million between Sept. 30, 2017, and March 31, 2018. Footnote 1 to the schedule of investments indicates the fund purchased those 27,134 shares on March 16, 2018. With respect to NexPoint Strategic Opportunities, the "summary of changes in the Fund's Level 3 assets (assets measured at fair value using significant unobservable inputs)" table in the footnotes of the fund's form N-Q dated March 31, 2018, shows it purchased TerreStar shares at a net cost of $2.5 million between Dec. 31, 2017, and March 31, 2018. The filing indicates the NexPoint fund held 132,801 TerreStar shares as of March 31, 2018, while the fund's annual report dated Dec. 31, 2017, shows the fund held 110,872 shares as of that date. Finally, the "summary of changes in the Company's Level 3 investments (measured at fair value using significant unobservable inputs)" table in the footnotes of NexPoint Capital's Form 10-Q dated March 31, 2018, shows that the entity purchased TerreStar shares at a net cost of $1.6 million between Dec. 31, 2017, and March 31, 2018, and that those shares had an estimated market value of $3.9 million as of March 31, 2018. The same filing's "schedule of investments" lists 14,035 TerreStar shares valued at $3.9 million as of March 31, 2018. This indicates that those shares represented the entirety of the entity's TerreStar equity stake as of that date and, thus, that the entity purchased these shares between Dec. 31, 2017, and March 31, 2018.

[8]See Highland Global Allocation annual report dated Sept. 30, 2018, note 10 "Affiliated Issuers," which indicates the fund sold 71,428 TerreStar shares between Sept. 30, 2017 (when it held 306,550 shares), and Sept. 30, 2018 (when it held 235,122 shares), netting proceeds of around $25 million. The fund's form N-Q dated June 30, 2018, indicates that it held 306,550 shares as of that date. Taken together, we can infer from these facts that the fund sold TerreStar shares in the third quarter of 2018 for $350 per share.

[9]"TerreStar has not demonstrated that there currently exists a shortage of WMTS spectrum capacity sufficient to warrant good cause to grant its extensive request for relief. In this regard, quite apart from the other inadequacies of TerreStar's waiver showing described above, we note that whether there is a need to devote additional spectrum to WMTS, particularly on a nationwide basis, is an open question, and the record of this proceeding provides an insufficient basis on which to address that issue." Source: "In the Matter of TerreStar Corporation Request for Temporary Waiver of Substantial Service Requirements for 1.4 GHz Licenses (WT Docket No. 16-290)," dated Oct. 10, 2017, paragraph 16.

[10]"Put differently, Verizon and other commenters state that auctioning the 1695-1710 MHz band as stand-alone uplink spectrum would render it 'virtually useless, as it is the downlink spectrum that carriers, both new and incumbent, most require to meet the skyrocketing demand for mobile broadband bandwidth.' They note that auctioning 1695-1710 MHz as standalone supplemental uplink would significantly decrease the value of the spectrum, relative to auctioning it paired with downlink spectrum, and would limit both its uses and interested bidders." Federal Register, Vol. 79, No. 107, dated June 4, 2014; 47 CFR Parts 1, 2, and 27, "Commercial Operations in the 1695-1710 MHz, 1755-1780 MHz, and 2155-2180 MHz Bands; Final Rule"; paragraph 20.

[11]Dish-controlled entities (SNR Wireless LicenseCo and Northstar Wireless) and TerreStar were the only bidders for most of the blocks TerreStar ultimately won in the 2015 auction. Thus, Dish already signaled, through the auction, that it was not willing to pay as much as TerreStar bid at auction for its licenses. (In aggregate, Dish bid around $0.45/MHz-PoP, or around 90% of what TerreStar ultimately purchased the blocks for.) The market for spectrum appears to have weakened since that 2015 auction. The 2017 broadcast spectrum (600 MHz) auction fetched a nationwide average of about $0.93/MHz-PoP, about a third of the $2.70/MHz-PoP the paired blocks in the 2015 auction commanded. To be sure, TerreStar's 1.7 GHz blocks are unpaired, not paired. But when pricing for spectrum that boasts greater versatility and reach than TerreStar's softens in this manner, it can indicate waning demand for capacity.

[12]The board considered various alternatives to converting Highland Global Allocation to a closed-end structure. Among them: Further liquidating the fund's TerreStar holdings; selling the TerreStar debt and equity to an affiliated Highland fund; contributing the TerreStar debt and equity into a subsidiary that would then be listed on a public exchange; merging Highland Global Allocation with a CEF; and, finally, contributing the TerreStar equity and debt into a wholly owned subsidiary and given shareholders proportional ownership of the subsidiary. (Highland Global Allocation definitive proxy statement dated Oct. 11, 2018, "Q: Did the Board consider options other than converting the Fund to a closed-end fund?")

[13]This would not be the first time Highland has misjudged a fund's liquidity profile, as the 2008 failure of Highland Crusader LP attests. That hedge fund suffered outflows at the same time the market for risky loans was drying up, forcing Highland to gate redemptions and embark on a multiyear process of liquidating the portfolio.

[14]Realized and unrealized gain and loss figures on TerreStar equity were compiled from the reconciliation of Level 3 starting and ending balances disclosed in the footnotes ("Note 2. Significant Accounting Policies/Fair Value Estimates"; the table is typically preceded by "The table below sets forth a summary of changes in the Global Allocation Fund's assets measured at fair value using significant unobservable inputs (Level 3) for the period ended…" or words to that effect) of Highland Global Allocation's periodic filings made between December 2014 and December 2018. A Highland spokesperson did not respond to a question on whether the fund had collected cash interest at any point from its investment in TerreStar senior debt.

[15]Source: Highland Global Allocation registration statement dated March 6, 2019.

Jeffrey Ptak does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.