Notes to Financial Statements
October 31, 2022
1. Organization
Miller/Howard High Income Equity Fund (the “Fund”) was formed as a Delaware statutory trust on April 21, 2011, and is registered under the Investment Company Act of 1940 (the “1940 Act”) as a closed-end, diversified management investment company. The Fund is managed by Miller/Howard Investments, Inc. (“Adviser”). The Fund commenced operations on November 24, 2014. The Fund’s stock is listed on the New York Stock Exchange under the symbol “HIE.”
The Fund will terminate on November 24, 2024, absent shareholder approval to extend such term. If the Fund’s Board of Trustees (“Board”) believes that under the current market conditions it is in the best interest of the Fund’s shareholders to do so, the Board may extend the termination date for one year, to November 24, 2025, without a shareholder vote upon the affirmative vote of three-quarters of the Board’s trustees then in office.
The Fund’s primary investment objective is to seek a high level of current income. As a secondary objective the Fund seeks capital appreciation when consistent with its primary investment objective. There can be no assurance that the Fund will achieve its investment objectives. The Fund will attempt to achieve its investment objectives by investing, under normal market conditions, at least 80% of its total assets in dividend or distribution paying equity securities of U.S. companies and non-U.S. companies traded on U.S. exchanges.
2. Significant Accounting Policies
The following is a summary of significant accounting policies followed by the Fund in preparation of its financial statements. The policies are in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Fund is an investment company and, accordingly, follows the investment company accounting and reporting guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 946, Investment Companies.
A. Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, recognition of distribution income and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates.
B. Security Valuation
Portfolio securities are valued at their current fair market value determined on the basis of market quotations or, if market quotations are not readily available or are deemed unreliable, at “fair value” as determined in accordance with procedures established by and under the general supervision of the Fund’s Board.
17 |
Annual Report | October 31, 2022 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
In general, the market values of securities which are readily available and deemed reliable are determined as follows: securities listed on a national securities exchange (other than securities listed on the NASDAQ Stock Market, Inc. (“NASDAQ”)) or on a foreign securities exchange are valued at the last sale price at the close of the exchange or foreign securities exchange. If there has been no sale on such day, the securities are valued at the mean price. Securities listed on more than one exchange are valued by reference to the principal exchange on which the securities are traded; securities listed only on NASDAQ are valued in accordance with the NASDAQ Official Closing Price; listed or over the counter (“OTC”) market put or call options are valued at the mid level between the current bid and ask prices. If either a current bid or current ask price is unavailable, the Adviser will have discretion to determine the best valuation (e.g., last trade price in the case of listed options).
Other securities may be valued on the basis of prices provided by a pricing service or at a price obtained from one or more of the major broker-dealers. In cases where broker-dealer quotes are obtained, the Adviser may establish procedures whereby changes in market yields or spreads are used to adjust, on a daily basis, a recently obtained quoted price on a security.
Securities for which market quotations are not readily available (including restricted securities) or are deemed unreliable are valued at fair value. Factors considered in making this determination may include, but are not limited to, information obtained by contacting the issuer, analysts, and analysis of the issuer’s financial statements or other available documents. In addition, the Fund may use fair value pricing for securities primarily traded in non-U.S. markets because most foreign markets close well before the Fund values its securities at 4:00 p.m., Eastern Time. The earlier close of these foreign markets gives rise to the possibility that significant events, including broad market moves, may have occurred in the interim and may materially affect the value of those securities.
The global outbreak of COVID-19 (commonly referred to as “coronavirus”) has disrupted economic markets and the prolonged economic impact is uncertain. The ultimate economic fallout from the pandemic, and the long-term impact on economies, markets, industries and individual issuers, are not known. The operational and financial performance of the issuers of securities in which the Fund invests depends on future developments, including the duration and spread of the outbreak, and such uncertainty may in turn adversely affect the value and liquidity of the Fund’s investments, and negatively impact the Fund’s performance.
C. Fair Value Measurement
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three-tier hierarchy is utilized to maximize the use of observable market data and minimize the use of unobservable inputs and to establish classification of fair value measurements for disclosure purposes. Inputs refer broadly to the assumptions that market participants would use in pricing
October 31, 2022 | Annual Report |
18 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
the asset or liability, including assumptions about risk. For example, market participants would consider the risk inherent in a particular valuation technique used to measure fair value, such as a pricing model, and/or the risk inherent in the inputs to the valuation technique. Inputs may be observable or unobservable. Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs are inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability and are developed based on the best information available in the circumstances. The three-tier hierarchy of inputs is summarized in the three broad levels listed below.
Level 1 – quoted prices in active markets for identical securities
Level 2 – other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.)
Level 3 – significant unobservable inputs (including the Fund’s own assumptions in determining the fair value of investments)
The availability of observable inputs can vary from security to security and is affected by a wide variety of factors, including, for example, the type of security, whether the security is new and not yet established in the marketplace, the liquidity of markets, and other characteristics particular to the security. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised in determining fair value is greatest for instruments categorized in level 3.
The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
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Annual Report | October 31, 2022 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
As of October 31, 2022, the Fund’s assets and liabilities carried at market value were classified as follows:
Investments in Securities(a) |
|
Total |
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock |
|
$ |
175,729,171 |
|
|
$ |
175,729,171 |
|
|
$ |
— |
|
|
$ |
— |
|
Master Limited Partnerships |
|
|
27,494,095 |
|
|
|
27,494,095 |
|
|
|
— |
|
|
|
— |
|
Real Estate Investment Trusts |
|
|
27,063,400 |
|
|
|
27,063,400 |
|
|
|
— |
|
|
|
— |
|
Short-Term Investment(b) |
|
|
12,362,602 |
|
|
|
12,362,602 |
|
|
|
— |
|
|
|
— |
|
Investments Purchased as Securities Lending Collateral(c) |
|
|
54,084,028 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Total Investment in Securities |
|
$ |
296,733,296 |
|
|
$ |
242,649,268 |
|
|
$ |
— |
|
|
$ |
— |
|
(a)
|
All industry classifications are identified in the Schedule of Investments.
|
(b)
|
Short-term investment is a sweep investment for cash balances in the Fund at October 31, 2022.
|
(c)
|
Certain investments that are measured at fair value using the net asset value per share (or its equivalent) have not been categorized in the fair value hierarchy in accordance with ASC 820. The fair value amounts presented in the table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the Statement of Assets and Liabilities.
|
The Fund did not hold any Level 3 Securities during the period ended October 31, 2022.
D. Security Transactions and Investment Income
Security transactions are accounted for on the date the securities are purchased or sold (trade date). Realized gains and losses are reported on a specific identified cost basis. Interest income is recognized on the accrual basis. Dividend income and distributions are recognized on the ex-dividend date, and withholding taxes on foreign dividends have been provided for in accordance with the Fund’s understanding of the applicable country’s tax rules and rates.
The Fund may hold the securities of real estate investments trusts (“REITs”). Distributions from such investments may include income, capital gains and return of capital. The Fund may also hold the securities of master limited partnerships (“MLPs”). Distributions from such investments may include income and return of capital. The actual character of amounts received during the year is not known until after the REIT and MLP fiscal year ends. The Fund records the character of distributions received from REITs and MLPs during the year based on estimates available. The characterization of distributions received by the Fund may be subsequently revised based on the information received from the REITs and MLPs after their tax reporting periods conclude.
October 31, 2022 | Annual Report |
20 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
E. Foreign Currency Translation
The books and records of the Fund are maintained in U.S. dollars. Foreign currency transactions are translated into U.S. dollars on the following basis: (i) market value of investment securities, assets and liabilities at the daily rates of exchange, and (ii) purchases and sales of investment securities, dividend and interest income, and certain expenses at the rates of exchange prevailing on the respective dates of such transactions. For financial reporting purposes, the Fund does not isolate changes in the exchange rate of investment securities from the fluctuations arising from changes in the market prices of securities. However, for Federal income tax purposes, the Fund does isolate and treat as ordinary income the effect of changes in foreign exchange rates on realized gain or loss from the sale of investment securities, and payables and receivables arising from trade-date and settlement-date differences.
F. Dividends and Distributions to Shareholders
The Fund intends to make regular monthly cash distributions of all or a portion of its investment company taxable income (which includes ordinary income and short-term capital gains) to common shareholders. The Fund also intends to make annual distributions of its “net capital gain” (which is the excess of net long-term capital gains over net short-term capital losses). The Fund will pay common shareholders annually at least 90% of its investment company taxable income. Various factors will affect the level of the Fund’s investment company taxable income, such as its asset mix. To permit the Fund to maintain more stable monthly distributions, the Fund may from time to time distribute less than the entire amount of income earned in a particular period, which would be available to supplement future distributions. As a result, the distributions paid by the Fund for any particular monthly period may be more or less than the amount of income actually earned by the Fund during that period.
Dividends from net investment income and distributions from realized gains from investment transactions have been determined in accordance with Federal income tax regulations and may differ from net investment income and realized gains recorded by the Fund for financial reporting purposes. These differences, which could be temporary or permanent in nature may result in reclassification of distributions; however, net investment income, net realized gains and losses, and net assets are not affected.
G. Federal Income Taxation
The Fund has elected to be treated as, and to qualify each year for special tax treatment afforded to, a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code (“IRC”). In order to qualify as a RIC, the Fund must, among other things, satisfy income, asset diversification and distribution requirements. As long as it so qualifies, the Fund will not be subject to U.S. federal income tax to the extent that it distributes annually its investment company taxable income and its net capital gain. The Fund intends to
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Annual Report | October 31, 2022 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
distribute at least annually all or substantially all of such income and gain. If the Fund retains any investment company taxable income or net capital gain, it will be subject to U.S. federal income tax on the retained amount at regular corporate tax rates.
H. Derivative Financial Instruments
The Fund provides disclosure regarding derivatives and hedging activity to allow investors to understand how and why the Fund uses derivatives, how derivatives are accounted for, and how derivative instruments affect the Fund’s results of operations and financial position.
The Fund occasionally sells (“writes”) put options on securities already held in its portfolio or securities that are candidates for inclusion in the portfolio. The strategy is designed to provide the Fund with the ability to acquire securities that the Adviser is interested in at attractive valuations while generating realized gains from premiums as a means to enhance distributions.
The Fund may occasionally purchase put options. A purchaser of a put option has the right, but not the obligation, to sell the underlying instrument at an agreed upon price (“strike price”) to the option seller.
The Fund occasionally sells (“writes”) call options on securities already held in its portfolio. The strategy is designed to generate realized gains from premiums as a means to enhance distributions.
The Fund may occasionally purchase call options. A purchaser of a call option has the right, but not the obligation, to purchase the underlying instrument at the strike price from the option seller.
Written Options – Premiums received by the Fund for written options are included in the Statement of Assets and Liabilities. The amount of the liability is adjusted daily to reflect the fair value of the written option and any change in fair value is recorded as unrealized appreciation (depreciation). Premiums received from written options that expire are treated as realized gains. The Fund records a realized gain (loss) on written options based on whether the cost of the closing transaction exceeds the premium received. If a call option is exercised by the option buyer, the premium received by the Fund is added to the proceeds from the sale of the underlying security to the option buyer and compared to the cost of the closing transaction to determine whether there has been a realized gain or loss. If a put option is exercised by an option buyer, the premium received by the option seller reduces the cost basis of the purchased security.
Written uncovered call options subject the Fund to unlimited risk of loss. Written covered call options limit the upside potential of a security above the strike price. Put options written subject the Fund to risk of loss if the value of the security declines below the exercise price.
October 31, 2022 | Annual Report |
22 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
Purchased Options – Premiums paid by the Fund for purchased options are included in the Statement of Assets and Liabilities as an investment. The option is adjusted daily to reflect the fair value of the option and any change in fair value is recorded as unrealized appreciation or depreciation of investments. If the option is allowed to expire, the Fund will lose the entire premium paid and record a realized loss for the premium amount. Premiums paid for purchased options which are exercised or closed are added to the amounts paid or offset against the proceeds on the underlying investment transaction to determine the realized gain/loss or cost basis of the security.
The Fund has adopted the disclosure provision of FASB ASC 815, Derivatives and Hedging. ASC 815 requires enhanced disclosures about the Fund’s use of and accounting for derivative instruments and the effect of derivative instruments on the Fund’s results of operations and financial position. Tabular disclosure regarding derivative fair value and gain/loss by contract type (e.g., interest rate contracts, foreign exchange contracts, credit contracts, etc.) is required and derivatives accounted for as hedging instruments under ASC 815 must be disclosed separately from those that do not qualify for hedge accounting. Even though the Fund may use derivatives in an attempt to achieve an economic hedge, the Fund’s derivatives are not accounted for as hedging instruments under ASC 815.
The following table presents the effect of derivatives on the Statement of Operations for the year ended October 31, 2022:
Derivatives not accounted for as
hedging instruments under ASC 815 |
|
Location of
Gains (Losses) on
Derivatives |
|
|
Net Realized
Gain (Loss) on
Derivatives |
|
|
Net Change
in Unrealized
Appreciation
(Depreciation) on
Derivatives |
|
Written equity options |
|
|
Options |
|
|
$ |
3,141,257 |
|
|
$ |
(34,328 |
) |
The average monthly notional value of written options for the Fund for the year ended October 31, 2022 was $6,487,520.
3. Concentration of Risk
The Fund’s investment objective is to seek a high level of current income. Under normal conditions, the Fund will have at least 80% of its total assets (including any assets obtained through leverage) invested in dividend or distribution paying equity securities of U.S. companies and non-U.S. companies traded on U.S. exchanges. Equity securities the Fund may invest in include common stocks, preferred stocks, convertible securities, warrants, depository receipts and equity interests in trust and other entities. The Fund may also invest up to 25% of its total assets in securities of MLPs.
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Annual Report | October 31, 2022 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
4. Agreements and Related Party Transactions
The Fund has entered into an Investment Advisory Agreement (the “Agreement”) with the Adviser. Under the terms of the Agreement, the Fund in the period ended October 31, 2022 paid the Adviser a fee equal to an annual rate of 1.00% of the Fund’s average weekly Managed Assets (defined as the average weekly total assets minus all accrued expenses incurred in the normal course of operations other than liabilities or obligations attributable to investment leverage, including, without limitation, investment leverage obtained though (i) indebtedness of any type (including, without limitation, borrowing through a credit facility or the issuance of debt securities), (ii) the issuance of preferred stock or other similar preference securities and/or (iii) the reinvestment of collateral received for securities loaned in accordance with the Fund’s investment objectives and policies). The Adviser earned $2,578,293 in advisory fees for the period ended October 31, 2022.
Effective as of the next Fund fiscal year beginning November 1, 2022, the Fund shall pay to the Adviser at the end of each calendar month a fee equal to an annual rate of 0.90% of the Fund’s average weekly Managed Assets.
U.S. Bank Global Fund Services serves as the Fund’s administrator and fund accountant.
American Stock Transfer & Trust Company, LLC serves as the Fund’s transfer agent, registrar and dividend disbursing agent and agent for the automatic dividend reinvestment plan.
U.S. Bank, N.A. serves as the Fund’s custodian.
One of the Fund’s Trustees is an employee of the Adviser.
5. Income Taxes
The Fund intends to continue to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code and distribute all or substantially all of its taxable income. Accordingly, no provision for federal income taxes is included in the financial statements.
The tax character of dividends paid to shareholders during the years ended October 31, 2021 and 2022, were as follows:
|
Ordinary
Income |
Net
Long Term
Capital Gains |
Return of
Capital |
Total
Distributions
Paid |
2021 |
$9,839,524 |
$— |
$627,254 |
$10,466,778 |
2022 |
$7,714,433 |
$— |
$3,107,468 |
$10,821,901 |
October 31, 2022 | Annual Report |
24 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
The amount and character of income and capital gain distribution to be paid, if any, are determined in accordance with federal income tax regulations, which may differ from U.S. GAAP. These differences could be temporary or permanent in nature. To the extent these differences are permanent in nature, such differences are reclassified at the end of the fiscal year among accumulated losses and paid-in capital. Accordingly, on October 31, 2022, accumulated losses were increased by $193,572 and paid-in capital was increased by $193,572. This reclassification has no effect on the net assets of the Fund.
The following information is provided on a tax basis as of October 31, 2022:
Cost of investments |
|
$ |
298,321,255 |
|
Unrealized appreciation |
|
$ |
22,318,298 |
|
Unrealized depreciation |
|
$ |
(23,906,257 |
) |
Net unrealized appreciation (depreciation) |
|
$ |
(1,587,959 |
) |
Undistributed ordinary income |
|
|
— |
|
Undistributed long term gains |
|
|
— |
|
Distributable earnings |
|
|
— |
|
Other accumulated gain/(loss) |
|
$ |
(34,167,023 |
) |
Total accumulated gain/(loss) |
|
$ |
(35,754,982 |
) |
At October 31, 2022 the Fund had capital loss carry forwards for federal income tax purposes available to offset future capital gains as follows:
|
|
Non-Expiring |
|
Short-Term |
|
$ |
8,534,050 |
|
Long-Term |
|
$ |
25,632,973 |
|
Total |
|
$ |
34,167,023 |
|
The Fund utilized $16,401,201 of capital loss carry forwards during the fiscal year.
The Fund recognizes the tax benefits of uncertain tax positions only where the position is “more likely than not” to be sustained assuming examination by tax authorities. Management has analyzed the Fund’s tax positions, and has concluded that no liability for unrecognized tax benefits should be recorded related to uncertain tax positions expected to be taken on U.S. tax returns and state tax returns of the Fund. The tax years 2019 through 2022 are open to examination by the tax authorities in the United States. The Fund is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change materially in the next 12 months. It is the Fund’s policy to record interest and penalties related to uncertain tax benefits as a component of income taxes, as appropriate.
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Annual Report | October 31, 2022 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
6. Investment Transactions
For the year ended October 31, 2022, the Fund purchased (at cost) and sold securities (proceeds received) in the amount of $287,299,161 and $301,979,316 (excluding short-term securities), respectively.
7. Common Stock
The Fund has unlimited shares of capital stock authorized and 18,690,675 shares outstanding at October 31, 2022. There were no transactions in common stock for the period ended October 31, 2022.
8. Special Custody Account Agreement
On September 19, 2017, the Fund entered into a $50,000,000 Special Custody Account Agreement (“Agreement”) with Interactive Brokers LLC (“Interactive Brokers”). The following shows the key terms of this agreement:
Loan Amount |
Interest Rate |
$0-$100,000 |
Federal Funds Rate + 1.50% |
$100,000.01-$1,000,000 |
Federal Funds Rate + 1.00% |
$1,000,000.01-$50,000,000 |
Federal Funds Rate + 0.75% |
$50,000,000.01+ |
Federal Funds Rate + 0.50% |
The average principal balance and interest rate for the year ended October 31, 2022 were $49,296,160 and 1.74%, respectively. On March 16, 2021, the Agreement was amended to increase the borrowing limit to $65,000,000. At October 31, 2022, the principal balance outstanding was $44,500,000 at an interest rate of 3.89%. The Fund may borrow up to an additional $20,500,000 under the Agreement.
Under the terms of the Agreement, the outstanding principal balance must be collateralized with securities of the Fund in an amount as specified in the Agreement. In addition, the Fund must maintain asset coverage required under the 1940 Act. If the Fund fails to maintain the required asset coverage, it may be required to repay a portion of an outstanding balance until the coverage requirement has been met. At October 31, 2022, the Fund was in compliance with the terms of the Agreement.
9. Securities Lending
The Fund may lend up to 33 1/3% of the value of the securities in its portfolio to brokers, dealers and financial institutions (but not individuals) under terms of participation in a securities lending program administered by U.S. Bank N.A. (“the Custodian”). The securities lending agreement requires that loans are collateralized at all times in an amount equal to at least 102% of the value of any loaned securities at the time of the loan, plus accrued interest. The Fund receives income from securities lending from fees paid to the Fund by the
October 31, 2022 | Annual Report |
26 |
Miller/Howard High Income Equity Fund
Notes to Financial Statements (continued)
October 31, 2022
borrowers and/or from the reinvestment of the cash collateral. Funds typically compensate their lending agents with a share of the revenue generated by the lending program, and may pay lending agents an additional fee for managing the cash collateral reinvestment. The amount of security lending income depends on a number of factors including the type of security and length of the loan. The Fund continues to receive dividends on the securities loaned during the borrowing period. Gain or loss in the fair value of securities loaned that may occur during the term of the loan will be for the account of the Fund. The Fund has the right under the terms of the securities lending agreement to recall the securities from the borrower on demand. The cash collateral is invested by the Custodian in accordance with approved investment guidelines. Those guidelines require the cash collateral to be invested in readily marketable, high quality, short-term obligations; however, such investments are subject to risk of payment delays or default on the part of the issuer or counterparty or otherwise may not generate sufficient interest to support the cost associated with lending. The Fund could also experience delays in recovering its securities and possible loss of income or value if the borrower fails to return the borrowed securities, although the Fund is indemnified from these risks by contract with the Custodian.
As of October 31, 2022, the value of securities on loan and payable for collateral due to broker were $52,676,490 and $54,084,028, respectively.
The cash collateral received was invested in the Mount Vernon Liquid Assets Portfolio, LLC (“Portfolio”) as shown on the Schedule of Investments. The Portfolio is a private fund that invests in high-quality, short term investments, similar to a money market fund, which can be redeemed daily. However, the Portfolio is not registered with the Securities and Exchange Commission (“SEC”) and is not required to meet the regulatory requirements of a money market fund registered with the SEC. The Portfolio is only offered to participants in the Custodian’s security lending program.
10. Indemnifications
Under the Fund’s organizational documents, its officers and trustees are indemnified against certain liabilities arising out of the performance of their duties to the Fund. In addition, in the normal course of business, the Fund may enter into contracts that provide general indemnification to other parties. The Fund’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Fund that have not yet occurred, and may not occur.
11. Subsequent Events
In preparing these financial statements, the Fund has evaluated events and transactions through the date of issuance for potential recognition or disclosure resulting from subsequent events. This evaluation did not result in any subsequent events that necessitated disclosures and/or adjustments to the financial statements.
27 |
Annual Report | October 31, 2022 |
Miller/Howard High Income Equity Fund