XAI Octagon Floating Rate & Alternative Income Term Trust (XFLT) N-CSRCertified annual shareholder report (management investment company)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED

MANAGEMENT INVESTMENT COMPANIES

811-23247

(Investment Company Act File Number)

XAI Octagon Floating Rate & Alternative Income Term Trust

(Exact Name of Registrant as Specified in Charter)

321 North Clark Street, Suite 2430

Chicago, IL 60654

(Address of Principal Executive Offices)

Benjamin D. McCulloch, Esq.

XA Investments LLC

321 North Clark Street, Suite 2430

Chicago, IL 60654

(Name and Address of Agent for Service)

(312) 374-6930

(Registrant’s Telephone Number)

Date of Fiscal Year End: September 30

Date of Reporting Period: September 30, 2021

Dear Shareholder:

We thank you for your investment in XAI Octagon Floating Rate & Alternative Income Term Trust (the “Trust”). This report covers the twelve months ended September 30, 2021 (the “Period”). During the Period, we observed the continuation of historic economic stimulus in the U.S. economy and the rollout of the COVID-19 vaccines. In December 2020, the U.S. government enacted an aid package totaling $900bn and another in March 2021, totaling $1.9 trillion. The rebound from 2020 has driven loan prices to levels not seen since October 2018. The loan market has continued to benefit from an accelerating economic recovery, strengthening corporate profitability and supportive market technicals.

This positive movement in loan prices has continued to improve CLO equity valuations and has manifested in CLO debt tranches posting positive performance across the capital stack in the first, second and third calendar quarters of 2021. The CLO market, through three calendar quarters in 2021, has also seen issuance levels that have surpassed the prior record for a full calendar year. We believe strong investor demand for higher-yielding floating rate product, coupled with a healthy new issue loan pipeline, should continue to provide support for the CLO market through 2021 calendar year-end.

The Trust’s net asset value (“NAV”) increased during the Period by 24.85% from $6.56 per common share to $8.19 per common share on September 30, 2021, largely reflecting gains and valuation increases for the Trust’s investments in collateralized loan obligation (“CLO”) equity, which had been depressed in the prior period.

For the twelve months ended September 30, 2021, the S&P 500 Index, the Bloomberg Barclays U.S. High Yield 1% Issuer Capped Index and the Trust’s benchmark, the S&P/LSTA Leveraged Loan 100 Index, generated total returns of 30.01%, 11.19%, and 6.66%,¹ respectively.

During the Period, the Trust declared monthly distributions totaling an aggregated $0.876 per common share. The monthly distribution of $0.073 per common share declared on September 1, 2021 represented an annualized distribution rate of 10.21% based on the Trust’s closing market price of $8.58 per common share on September 30, 2021.

The closing price per common share of $8.58 on September 30, 2021 also represented 4.76% premium to NAV of $8.19 per common share. During the Period, the Trust’s common shares traded on average at a 8.89% premium to NAV. From the Trust’s IPO on September 27, 2017 through September 30, 2021, the Trust’s common shares have traded on average at a 2.43% premium to NAV.

During the Period, the Trust issued an additional 6,743,035 common shares pursuant to an “at-the-market” offering program, resulting in $58,288,860 of gross proceeds to the Trust. The Trust also sold an additional 3,269,302 common shares in February 2021 and 3,565,000 common shares in July 2021, respectively, through two separate underwritten offerings, the second and third of this type of underwritten “overnight offering” for the Trust since inception. The underwritten offerings resulted in gross proceeds of $28,181,383 (before deduction of the sales load and offering expenses) and $30,302,500 (before deduction of the sales load and offering expenses), respectively, to the Trust.

The Trust also issued 1,196,000 shares of the Trust’s 6.50% Series 2026 term preferred shares (the “Preferred Shares”) in an underwrittten offering on March 29, 2021, resulting in gross proceeds of $29,900,000 (before the deduction of sales load and offering expenses) to the Trust. The Preferred Shares have a 5-year term and were issued at a rate of 6.50%. The Preferred Shares trade on the NYSE under the symbol XFLTPRA. Following the initial offering in September, the Trust completed a direct placement of 400,000 additional shares of the Preferreds Shares at an issuance price of the liquidation preference plus accrued dividends from July 31, 2021 to the date of issuance. The direct placement raised proceeds of approximately $10,000,000 (before the deduction of expenses).

We appreciate your investment and look forward to serving your investment needs in the future. For the most up-to-date information on your investment, please visit the Trust’s website at www.xainvestments.com/XFLT.

Sincerely,

Kimberly Flynn

Managing Director

XA Investments LLC

XA Investments LLC (“XAI”) serves as the investment adviser to the Trust. Octagon Credit Investors, LLC (“Octagon”) serves as the Trust’s investment sub-adviser and is responsible for the management of the Trust’s portfolio of investments.

Gretchen M. Lam, Senior Portfolio Manager at Octagon Credit Investors, LLC (“Octagon”) and a member of Octagon’s Investment Committee serves as lead portfolio manager of XAI Octagon Floating Rate & Alternative Income Term Trust (the “Trust”). Ms. Lam is supported by a team of Octagon investment professionals in the day-to-day management of the Trust’s portfolio, including the following members of Octagon’s Investment Committee: Andrew D. Gordon (Octagon’s co-founder and Chief Executive Officer), Michael B. Nechamkin (Chief Investment Officer and Senior Portfolio Manager), Lauren B. Law (Portfolio Manager), and Sean M. Gleason (Portfolio Manager). In addition, Maegan Gallagher (Head of Trading and Capital Markets) is a member of the Octagon Investment Committee.

What is the Trust’s investment objective and how is it pursued?

The Trust’s investment objective is to seek attractive total return with an emphasis on income generation across multiple stages of the credit cycle. The Trust seeks to achieve its investment objective by investing in a dynamically managed portfolio of opportunities primarily within the private credit markets. Under normal market conditions, the Trust will invest at least 80% of its Managed Assets in floating-rate credit instruments and other structured credit investments.

The Trust’s investments may include (i) structured credit investments, including collateralized loan obligation (“CLO”) debt and subordinated (i.e., residual or equity) securities; (ii) traditional corporate credit investments, including leveraged loans and high yield bonds; (iii) opportunistic credit investments, including stressed and distressed credit situations and long/short credit investments; and (iv) other credit-related instruments.

Leveraged loans are debt obligations (also commonly referred to as “senior loans” or “floating-rate loans”) issued by a bank to a corporation that generally holds legal claim to the borrower’s assets above all other debt obligations.

CLOs are a type of structured credit vehicle that typically invest in a diverse portfolio of broadly syndicated leveraged loans. CLOs finance this pool of loans with a capital structure that consists of debt and equity. CLO debt includes senior and mezzanine debt (collectively, “liabilities”) of a CLO structure with tranches rated from AAA down to BB or B. Interest earned from the underlying loan collateral pool of a CLO is used to pay the coupon interest on the CLO liabilities. CLO debt investors earn returns based on spreads above 3-month LIBOR. “LIBOR” stands for London Interbank Offered Rate and is the benchmark rate that most of the world’s leading banks charge each other for short-term loans. CLO equity represents a residual stake in the CLO structure and is the first loss position in the event of defaults and credit losses. CLO equity investors receive the excess spread between the CLO assets and liabilities and expenses. CLO equity is junior in priority of payment and is subject to certain payment restrictions generally set forth in an indenture governing the notes.

The Trust pursues its investment objective by investing primarily in below investment grade credit instruments that are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and to repay principal. The Trust may invest without limitation in credit instruments that are illiquid.

The Trust uses leverage to seek to enhance total return and income. Although leverage may create an opportunity for increased return and income for shareholders, it also results in additional risks and can magnify the effect of any losses. There is no assurance that the leverage strategy will be successful. If income and gains on securities purchased with leverage proceeds are greater than the cost of the leverage, common shareholders’ return will be greater than if leverage had not been used. Conversely, if the income or gains from the securities purchased with the proceeds of leverage are less than the cost of leverage, common shareholders’ return will be less than if leverage had not been used.

Describe the current market conditions for the leveraged loan market and Octagon’s outlook.

Leveraged loans returned 8.40% for the 12 months ended September 30, 2021 (the “Period”), as measured by the S&P/LSTA Leveraged Loan Index (the “LLI”),¹ reflecting firm market conditions throughout the Period. On the heels of strong performance in the fourth calendar quarter of 2020 (during which loans returned 3.81%¹), over the course of calendar 2021, loans have benefited from the trifecta of an accelerating economic recovery, strengthening corporate profitability, and supportive market technicals. Loans have gained 4.42% on a year-to-date basis as of September 30, 2021, which compares to a -0.66% loss in the same period in 2020 (based on total return).¹ For further historical context, the asset class has returned 3.82%, on average, between January and September over the last 12 years.¹

The sharp economic rebound from 2020, improving credit fundamentals, and exceptionally strong demand for floating rate assets have driven loan prices to levels not seen since October 2018. New loan issuance has surged amid continued price appreciation, favorable borrowing costs for borrowers, and robust investor demand, with private equity-backed transactions comprising the lion’s share of year-to-date primary market volume. As of September 30, 2021, year-to-date LBO and overall M&A-backed new loan issuances are tracking at record levels ($124 billion and $250 billion, respectively).² The pace of loan repricing activity has dissipated following a wave of repricings in the first calendar quarter of 2021, though opportunistic deal flow has continued apace in the form of dividend recapitalizations. 2021 calendar year-to-date recap volume ($67.2 billion as of September 30, 2021) is already a full-year record.² All told, institutional new loan issuance totaled $155 billion in the third calendar quarter of 2021, up from $147 billion in the second quarter, but below the $185 billion record set in the first quarter.² At $487 billion year-to-date as of September 30, 2021, the loan market is on course to surpass the annual new issuance record of $503 billion reached in 2017.² We expect the pace of primary activity will remain brisk in the final calendar quarter of 2021. Robust new loan supply has been absorbed by institutional and retail investors on the hunt for higher-yielding, floating rate assets. In particular, record CLO demand has provided a strong bid for loans. New CLO formation hit a new record high of $46.7 billion in the third calendar quarter of 2021, the third consecutive period of record quarterly issuance, following $43.4 billion and $39.8 billion of new deals in the second and first quarter of 2021, respectively.² Despite heavy new supply and some loan spread compression year-to-date, primary CLO spreads have generally remained rangebound and the arbitrage remains attractive.³ Meanwhile, retail loan funds have recorded steady inflows over ten consecutive months.⁴ In the wake of 2020 outflows totaling $26.9 billion, year-to-date retail loan fund inflows total $34.9 billion as of September 30, 2021.⁵ Given ongoing concerns over inflation and rising rates, we anticipate continued demand for floating rate assets, which should be supportive for the loan and CLO markets.

Credit fundamentals continued to improve during the Period, fueled by a sharp rebound in corporate earnings in the first and second calendar quarters of 2021. By and large, loan issuers reported strong second quarter earnings, with several companies posting double-digit year-over-year gains. Revenue and EBITDA growth among borrowers has supported ongoing rating agency upgrade activity throughout 2021; in September, loan facility upgrades among LLI constituents outnumbered downgrades for an eighth consecutive month.⁶ Amid receding credit stress, the trailing 12- month default rate for the LLI declined for the 12th consecutive month to 0.35% as September 30—the lowest level in nine years and a significant reversal from the cycle peak of 4.17% reached in September 2020.⁵ As the global economy continues to recover, we anticipate defaults will remain low and credit fundamentals will generally continue to improve, though we expect to see some earnings misses and revised guidance driven largely by the impacts of supply chain disruptions and higher input costs. In the context of a benign default environment and supportive technical dynamics, we believe leveraged loans offer attractive risk-adjusted return opportunities. We will continue to rely on fundamental credit research, disciplined asset selection, and active portfolio management to seek to identify relative value opportunities with alpha potential.

Describe the current market conditions for the CLO market and Octagon’s outlook.

Both CLO debt and equity tranches performed well over the Period. CLO debt tranches posted positive performance across the capital stack in the first, second, and third calendar quarters of 2021; meanwhile, CLO equity valuations have continued to improve alongside rising loan prices. 2021 has been a record-breaking year for the CLO market; as of September 30, 2021, year-to-date US CLO issuance of $129.8 billion has already exceeded the full-year record ($129 billion set in 2018), thanks to three consecutive quarters of record-setting new deal activity amid robust investor demand for CLO paper, heavy new loan supply, and favorable CLO liability costs.⁷ CLO refinancing and reset activity has also continued at a brisk pace, with $88.9 billion of deal refinancings and $103.2 billion of resets priced year-to-date as of September 30, 2021.⁶

After contracting to multi-year lows in early 2021, new issue CLO funding costs (i.e., the weighted average cost of CLO notes/liabilities, which are priced at a set coupon/spread over LIBOR) increased slightly in the second quarter in tandem with AAA spreads rising by approximately 0.10%, and have since remained relatively rangebound on the back of heavy new deal supply. At 2.23% as of September 30, 2021, the estimated arbitrage for new issue CLOs remains comparatively attractive to post-crisis lows (approximately L+1.80% in 2018).⁸

A favorable economic outlook, improving corporate earnings, higher CCC-rated loan prices, attractive loan spread levels, positive loan ratings actions, and very few loan defaults have continued to drive further improvements in underlying loan portfolios and CLO coverage tests. CLO portfolio CCC- rated concentrations and weighted average rating factor (WARF) levels have benefited from higher loan prices and ongoing loan facility upgrade activity over the course of 2021. As of September 30, 2021, median CCC/Caa-rated levels for CLO portfolios were 5.4% and 4.5%, respectively, representing a decrease over the last twelve months of 3.1 and 2.7 percentage points, respectively.⁶ Moreover, the percentage of lower-priced loans and defaulted assets held in CLO portfolios has declined to post-crisis lows. As of Period-end, less than 3% of loans held in CLO portfolios were trading below $90. In early September 2021, Fitch reported that default exposure across CLO portfolios had declined to 0.3%—the lowest level since mid- 2019—with only six out of approximately 1,500 obligors identified as being in default at the end of August.⁹ After peaking at 25% in May 2020, the portion of reinvesting CLOs currently failing one or more overcollateralization (O/C) test has sequentially declined to nearly 0%.¹⁰ Less than 1% of CLOs did not pay an equity distribution in October 2021, compared to 7% in April/May 2020.⁹ Lower forecasted loan default rates and expectations of healthy corporate earnings growth should provide continued support for underlying loan portfolios and CLO fundamentals.

Although the loan repricing wave in the first calendar quarter of 2021 reduced the weighted average spread for CLO portfolios by approximately 0.07%, CLO equity distributions have nevertheless remained relatively stable in the 3.6%-4% range over 2021,⁹ reflecting the benefits of LIBOR floors, fewer missed payments due to CLO overcollateralization test failures, lower LIBOR levels, and lower CLO liability costs due to deal refinancings and resets. Year-to-date as of September 30, 2021, the estimated median equity cash-on-cash quarterly distribution for CLOs is 3.8%, compared to 3.0% in the second half of 2020.³ The share of underlying loans with LIBOR floors held in CLO portfolios has steadily increased over the year to approximately 50%, with the average LIBOR floor currently hovering around 0.80%.⁹ In turn, the LIBOR floor benefit has contributed approximately 0.32% to CLO portfolio weighted average spread levels as of early October 2021.⁹

Strong investor demand for higher-yielding floating rate product, coupled with a healthy new issue loan pipeline, should continue to provide support for the CLO market through 2021 calendar year-end. Furthermore, the high number of open CLO warehouses (200+ based on current estimates¹¹) should support continued issuance in the near-term. However, as loan prices have moved closer to par amid continued robust investor demand, we recognize the potential for increased loan repricing activity, which could consequently impact CLO portfolio margins and CLO equity distribution levels. We anticipate robust new CLO issuance in the first half of the fourth calendar quarter of 2021, as managers endeavor to close deals ahead of the market’s expected transition to SOFR-linked issuance at year-end. “SOFR” stands for the CME Group’s forward-looking Term Secured Overnight Financing Rate. CLO reset activity is likewise expected to continue apace in the near-term, based on the count of deals due to exit their non-call period and be eligible for a deal reset or refinancing before year-end.¹² We maintain the view that elevated CLO reset activity could prove accretive to the Trust’s CLO equity positions; should any CLOs in the Trust’s portfolio execute a refinancing or reset, the tighter CLO liability costs may significantly benefit equity investors over the long-term. It is still unclear what will be deemed as a reasonable spread basis for the first SOFR-based CLOs. The high count of currently open CLO warehouses indicates sustained CLO equity demand and strong forward supply levels, which further suggests that CLO equity investors are generally accepting of the presumed risks associated with the impending transition away from LIBOR.

It bears noting that the CLO market is prone to episodic bouts of market volatility as technical dynamics shift, which we would generally view as a buying opportunity for the Trust. We maintain the view that potential bouts of market turbulence can benefit CLO equity. When credit spreads widen, loan prepayments and amortizations are typically recycled into discounted/higher yielding assets during periods of market volatility, while CLO liability spreads are fixed, resulting in higher CLO equity distributions. We therefore believe CLO equity continues to offer compelling risk-adjusted returns to long-term investors seeking income strategies.

How did the Trust perform for the twelve months ended September 30, 2021?

For the twelve-month period ended September 30, 2021, the Trust’s total return on market price was 59.63% and total return based on net asset value (“NAV”) was 39.14%. NAV return includes the deduction of management fees, operating expenses, and all other Trust expenses. All Trust returns cited – whether based on NAV or market price – assume the reinvestment of all distributions. As of September 30, 2021, the Trust’s market price of $8.58 represented a premium of 4.76% to its NAV of $8.19. The market value of the Trust’s shares fluctuates from time-to-time and may be higher or lower than the Trust’s NAV. Performance data quoted represents past performance. Past performance does not guarantee future results. Current performance may be lower or higher than the performance data quoted.

What were the distributions over the period?

For the October 1, 2020 distribution payment which was declared on September 1, 2020, the Trust paid a monthly distribution of $0.060 per share. From November 1, 2020 through September 1, 2021, the Trust paid a monthly distribution of $0.073 per share. The Trust’s declared distribution payable on October 1, 2021, is consistent with the previous twelve distributions and represents annualized distribution rate of 10.21% based on the Trust’s closing market price of $8.58 per common share on September 30, 2021. The Trust’s distribution rate is not constant, and the amount of distributions, when declared by the Trust’s Board of Trustees, is subject to change based on the performance of the Trust.

The Trust intends to pay substantially all of its net investment income, if any, to common shareholders through monthly distributions and to distribute any net realized long-term capital gains to common shareholders at least annually. The Trust’s net investment income and capital gain can vary significantly over time; however, the Trust seeks to maintain more stable common share monthly distributions over time. There is no assurance the Trust will pay regular monthly distributions or that it will do so at a particular rate. Distributions may be paid by the Trust from any permitted source and, from time to time, all or a portion of a distribution may be a return of capital.

Please see Note 4 of the Notes to the Financial Statements for more information on distributions for the period.

What influenced the Trust’s performance for the 12 months ended September 30, 2021?

The Trust generated positive returns across its main portfolio segments during the Period. CLO equity represented the largest contributor to performance for the 12-month period, reflecting improved CLO equity valuations owing to higher underlying loan prices, as well as strong quarterly cash flows received during the Period. The Trust’s CLO equity segment experienced a net gain of approximately $1.65 per share for the Period, during which the Trust’s CLO equity positions collected quarterly distribution payments totaling $19,286,779 or $1.05 per share, which were augmented by market value gains of $11,115,990 or $0.60 per share. It bears noting that the Trust’s daily CLO equity pricing can be very volatile. CLO equity valuations often reflect the relative opaqueness of the secondary CLO equity market. The Trust’s performing loan portfolio segment produced a net gain of approximately $0.46 per share for the period, followed by net gains in the Trust’s CLO debt and high yield bond segments of $0.17 and $0.04, respectively.

Relevant indices for the markets in which the Trust invests include the Trust’s benchmark, the S&P/LSTA Leveraged Loan 100 Index, which returned 6.66% for the 12-month period, Bloomberg Barclays U.S. High Yield 1% Issuer Capped Index, which returned 11.19% for the twelve-month period, and the JP Morgan BB/B CLO Debt Index, which returned 24.69% for the 12-month period. There is no representative benchmark index for CLO equity in the marketplace.

How is the Trust positioned for the remainder of 2021?

Looking ahead, we believe that the Trust is well-positioned across its primary investment segments to pursue its investment objective and capitalize on any potential bouts of market volatility through 2021 calendar year-end. As of September 30, 2021, the Trust is invested predominantly in floating rate assets, comprising first and second lien loans (42.2% of the total portfolio on a market value basis as of September 30, 2021), CLO equity (39.7%) and CLO debt securities (9.52%). We have sought to appropriately diversify the Trust’s loan positions across industry sectors, with software, health care providers and services, and diversified consumer services representing the largest exposures as of September 30, 2021. The Trust’s CLO debt investments remain predominantly comprised of BB rated tranches; we believe moderating tail risk in underlying loan portfolios should bode well for CLO mezzanine debt and CLO equity. We retain a constructive view of CLO equity, reflecting our expectation that improvements in underlying collateral portfolios should support stable-to-improving CLO equity NAVs, absent pronounced volatility in the market.

Discuss the Trust’s secondary market performance and issuance of additional common shares.

During the twelve months ended September 30, 2021, the Trust issued 6,743,035 common shares pursuant to an “at-the-market” (“ATM”) offering program resulting in $57,705,408 of net proceeds to the Trust. The ATM program is a form of continuous follow-on offering of the Trust’s common shares. The goal of the Trust’s ATM program is to enhance secondary market liquidity for shareholders by growing the size of the Trust over time and reducing operating expenses per share. In an ATM offering, newly issued shares are sold incrementally into the secondary trading market through a placement agent at prevailing market prices, but always at or above the Trust’s NAV. The placement agent sells the common shares in the open market and the Trust receives cash proceeds from the transaction to be invested pursuant to the Trust’s investment objectives. The Trust has been able to deploy the investment proceeds from the Trust’s ATM program in what Octagon believes are attractive investment opportunities.

The Trust issues common shares pursuant to the ATM program only if the shares are trading at a sufficient premium such that the issuance price, less the placement fee, exceeds the Trust’s NAV per share. For the twelve-month period ended September 30, 2021, the Trust’s common shares traded at an average 8.89% premium to NAV and had average daily trading volumes of 176,720 common shares. ATM program daily issuance totals depend on the common shares’ average daily trading volumes and market price’s relative premium or discount to NAV.

The Trust also sold an additional 3,269,302 and 3,565,000 common shares through two underwritten offerings in February 2021 and July 2021, respectively. These represented the second and third underwritten “overnight offerings” for the Trust since its inception. The underwritten offerings resulted in gross proceeds of $28,181,383 and $30,302,500 (each before deduction of the sales load and offering expenses) to the Trust, respectively. For both offerings, the common shares were issued at a premium to the Trust’s NAV. In the February offering shares were issued at an price of $8.62 while NAV was at $7.80, and in the July offering shares were issued at a price of $8.50 while NAV was at $8.06. Each underwritten offering resulted in an accretive asset raise for the Trust and its shareholders.

How is the Trust positioned to perform in the current interest rate environment?

The Trust remains conservatively positioned in terms of duration; the vast majority of the Trust’s portfolio is invested in floating-rate or adjustable securities based on changes in LIBOR, as further explained below. Three-month LIBOR modestly declined during the period, from 0.23% as of October 1, 2020 to 0.13% as of September 30, 2021.¹³ Lower LIBOR has resulted in comparatively lower all-in yields for leveraged loans and CLO debt tranches. Despite lower short-term rates, we believe the loan market currently offers comparatively attractive total return and income potential for long-term investors.

In certain instances, over the Period we observed inflationary pressures positively or negatively impacting the operating margins for the issuers in which the Trust invests. Inflationary pressures may continue to be a near-term headwind for some corporate borrowers, though it bears noting that such impacts vary by issuer and business. We are therefore focused on prudently managing the Trust’s exposure to issuers that are or may be negatively impacted by inflationary pressures, while also seeking opportunities to invest in issuers whose businesses can withstand any negative inflation-related impacts, and/or potentially benefit from rising inflation.

The Period was marked by several major announcements concerning the future of LIBOR. Within the US loan and CLO markets, these developments provided clarity regarding the timing of LIBOR’s end and the implementation of fallback rates in loans, CLO debt tranches, and other instruments that reference LIBOR. On March 5, 2021, the Financial Conduct Authority (FCA) and the ICE Benchmark Administration (IBA) confirmed that pound, sterling, Euro, Swiss franc and Japanese yen LIBOR settings, and 1-week and 2-month US dollar LIBOR settings will cease to be published after December 31, 2021 for legacy contracts. All other tenors of US dollar LIBOR, including 1-month and 3-month rates, will terminate on June 30, 2023, as initially announced by the FCA and IBA on November 30, 2020. On July 29, 2021, the Alternative Reference Rates Committee (ARRC) officially recommended the CME Group’s SOFR for use in the bank loan market, however, there is uncertainty with respect to replacement of LIBOR with proposed alternative reference rates, and it is possible that different markets might adopt different rates, resulting in multiple rates at the same time and a potential mismatch between CLO securities and underlying collateral, the effects of which are uncertain at this time, and could include increased volatility or illiquidity. The OCC, the FDIC, and the Federal Reserve have directed US banks to stop originating new LIBOR-linked contracts after December 31, 2021. It is uncertain when the timing of the benchmark transition will take place for legacy CLO liabilities as LIBOR transition language in US CLO documents varies across CLO transactions and vintages, though there are various fallback language options outlined in CLO documents. It is expected that new issue loans will begin referencing a SOFR-based benchmark starting in January 2022, however this timeframe is uncertain and could also accelerate. Accordingly, it is expected that a mismatch of reference rates will exist for a period of time between CLO liabilities and at least a portion of underlying loans within CLO portfolios, which could have a negative impact on overall returns. CLO equity holders are ultimately expected to absorb the temporary basis risk, which is conceptually similar to existing basis risk mismatches between LIBOR tenors in use (e.g. 1-month vs. 3-month LIBOR). While the longer-term impact to CLO equity distributions will depend on the deal mechanics/vintage, whether the credit spread adjustment is added to CLO liabilities, and the timing of the LIBOR/SOFR transition for loans and for CLO liabilities (among several other factors), the prevalence of LIBOR floors in underlying loans should help to mitigate basis risk during the transition period.

Discuss the Trust’s use of leverage.

The Trust uses leverage as part of its investment strategy to finance the purchase of additional securities that may provide increased income and greater appreciation potential to common shareholders than could be achieved from a portfolio that is unlevered. With the current low cost of borrowing, the amount of leverage used by the Trust is expected to be accretive to income generation. The Trust currently employs leverage through the combination of a bank borrowing facility and preferred shares outstanding. The Trust’s bank borrowing facility was amended during the Period to allow the Trust to borrow up to $125,000,000. As of September 30, 2021, the amount of outstanding borrowings under the facility was $98,150,000, which represented approximately 27.52% of the Trust’s Managed Assets (including the proceeds from borrowing). Additionally, as of September 30, 2021, the Trust issued preferred shares having a total liquidation preference of $39,900,000. Total leverage, as of September 30, 2021 was $138,050,000, representing 38.71% of the Trust’s Managed Assets.

The Trust may use leverage through (i) the issuance of senior securities representing indebtedness, including through borrowing from financial institutions or issuance of debt securities, including notes or commercial paper, (ii) the issuance of preferred shares and/or (iii) reverse repurchase agreements, securities lending, short sales or derivatives, such as swaps, futures or forward contracts, that have the effect of leverage. The terms of the credit facility require that if the Trust’s borrowings exceed 33 1/3% of the Trust’s managed assets, the Trust must reduce its borrowings below such ratio within a specified period of time. Because a portion of the Trust’s assets may consist of illiquid investments, to the extent that the Trust must dispose of portfolio holdings to meet such asset coverage ratio, the Trust may be required to dispose of more liquid holdings at times or on terms that the Trust would otherwise consider undesirable, which may pose particular risks during adverse or volatile market conditions. While leverage may increase the income of the Trust in yield terms, it also amplifies the effects of changing market prices in the portfolio and can cause the Trust’s NAV to change to a greater degree than the market as a whole. This change in NAV can create volatility in Trust pricing.

Index Definitions

The Trust does not seek to track any index. Index returns are stated for illustrative purposes only, do not reflect the deduction of fees and expenses, and do not represent the performance of the Trust. It is not possible to invest directly in an index. There is no representative index CLO equity securities.

Bloomberg Barclays U.S. High Yield 1% Issuer Capped Index measures the U.S. dollar-denominated, high yield, fixed-rate corporate bond markets. Securities are classified as high yield if the middle rating of the Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. Issuers are capped at 1% of the index.

J.P. Morgan CLO Debt Index represents the post-crisis J.P. Morgan Collateralized Loan Obligation Index (“CLOIE”). The CLOIE is an index that tracks the market for U.S. dollar-denominated broadly syndicated, arbitrage CLOs. The CLOIE is divided by origination (pre- versus post-crisis) and is broken out further into six original rating classes (AAA, AA, A, BBB, BB, B). The sub-index we reference here tracks BB-rated CLO debt.

The S&P/LSTA Leveraged Loan Index (LLI) is a capitalization-weighted syndicated loan index based upon market weightings, spreads and interest payments. The LLI was introduced in 2001 and covers the U.S. loan market back to 1997 and currently calculates on a daily basis. The LLI generally mirrors the universe of broadly syndicated US leveraged loans.

S&P/LSTA U.S. Leveraged Loan 100 Index is a market value-weighted index designed to measure the performance of the U.S. leveraged loan market. In conjunction with S&P Global, the Leveraged Syndications & Trading Association (“LSTA”) developed the S&P/LSTA U.S. Leveraged Loan 100 Index. The S&P/LSTA U.S. Leveraged Loan 100 Index is designed to reflect the 100 largest loan facilities in the leveraged loan market. It mirrors the market- value-weighted performance of the 100 largest institutional leveraged loans based upon actual market weightings, spreads and interest payments. The S&P/LSTA U.S. Leveraged Loan 100 Index utilizes LSTA/LPC Mark-to-Market Pricing, which is based on bid/ask quotes gathered from dealers and is not based upon derived pricing models. The index uses the average bid for its market value calculation. Each loan facility’s total return is calculated by aggregating the interest return (reflecting the return due to interest paid and accrued interest) and price return (reflecting the gains or losses due to changes in the end of day prices and principal repayments). The return of each loan facility is weighted in the index based upon its market value outstanding, which reflects both the prior period’s prices as well as accrued interest. The overall index return is the aggregate of each component loan facility’s return multiplied by the market value outstanding from the prior time period.

Risks and Other Considerations

Investing involves risk, including the possible loss of principal and fluctuation in value.

The views expressed in this Management Discussion of Fund Performance reflect those of the portfolio managers only through the report period as stated on the cover. These views are expressed for informational purposes only and are subject to change at any time, based on market and other conditions, and may not come to pass. These views should not be construed as research, investment advice or a recommendation of any kind regarding the Trust or any issuer or security, do not constitute a solicitation to buy or sell any security, and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific investor.

The views expressed in this report may also include forward-looking statements that involve risk and uncertainty, and there is no guarantee that any predictions will come to pass. Actual results or events may differ materially from those projected, estimated, assumed, or anticipated in any such forward looking statements. Important factors that could result in such differences, in addition to the other factors noted with such forward-looking statements, include general economic conditions such as inflation, recession, and interest rates. Neither XAI nor Octagon has any obligation to update or otherwise revise any forward-looking statements, including any revision to reflect changes in any circumstances arising after the date hereof relating to any assumptions or otherwise.

There can be no assurance that the Trust will achieve its investment objective or that any investment strategies or techniques discussed herein will be effective. The value of the Trust will fluctuate with the value of the underlying securities. Historically, closed-end funds often trade at a discount to their net asset value.

Performance data quoted represents past performance. Past performance does not guarantee future results. Current performance may be lower or higher than the performance data quoted.

Investing in closed-end funds involves risk; principal loss is possible. There is no guarantee the Trust’s investment objective will be achieved. Closed-end fund shares may frequently trade at a discount or premium to their net asset value. Senior loans may not be fully secured by collateral, generally do not trade on exchanges, and are typically issued by unrated or below-investment grade companies, and therefore are subject to greater liquidity and credit risk. Lower credit debt securities maybe more likely to fail to make timely interest or principal payments. Leverage increases return volatility and magnifies the Trust’s potential return and its risks; there is no guarantee a trust’s leverage strategy will be successful. The Trust’s shares are not guaranteed or endorsed by any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation.

Distribution rates are not performance and are calculated by summing the quarterly distributions per share over four quarters and dividing by the NAV or market price, as applicable, as of the latest quarter end. Distributions may be comprised of ordinary income, net capital gains, and/or a return of capital (ROC) of your investment in the Trust. The actual components of the Trust’s distributions for U.S. tax reporting purposes can only be finally determined as of the end of each fiscal year of the Trust and are thereafter reported on Form 1099-DIV. The Trust’s distributions for fiscal year ended 2020 comprised 97.50% net income and 2.50% return of capital. The Trust’s distributions for fiscal year ending 2021 will be made available and reported to investors subsequent to the end of fiscal year 2021. A distribution comprised in whole or in part by a return of capital does not necessarily reflect the company’s investment performance and should not be confused with “yield” or “income.” Future distributions may consist of a return of capital.

Please see “Risks” for more information regarding the Trust’s risks and considerations.

Visit the Trust’s website (www.xainvestments.com/XFLT) for additional information regarding the Trust. The Trust regularly updates performance and certain other data and publishes material information as necessary from time to time on its website. Investors and others are advised to check the website for updated performance information and the release of other material information about the Trust. References herein to the Trust’s website are intended to allow investors public access to information regarding the Trust and do not, and are not intended to, incorporate the Trust’s website in this report.

This material is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. All content has been provided for informational or educational purposes only and is not intended to be, and should not be construed as, legal or tax advice and/or legal opinion. Always consult a financial, tax, and/or legal professional regarding your specific situation.

Growth of a $10,000 Investment (as of September 30, 2021)

The chart above represents historical performance of a hypothetical investment of $10,000 in the Trust since inception. Past performance does not guarantee future results. Performance reflects the partial waiver of the Trust’s advisory fees and/or reimbursement of expenses for certain periods since the inception date. Without these waivers and/or reimbursements, performance would have been lower. This chart does not reflect the deduction of taxes that a shareholder would pay on Trust distributions or the redemption of Trust shares. The chart assumes that distributions from the Trust are reinvested.

Summary Performance (as of September 30, 2021)

Performance data quoted represents past performance. Past performance does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than performance data quoted.

Top Ten Portfolio Holdings (as a % of Total Investments)*

Total may not add up to 100% due to rounding.

Holdings may vary and are subject to change.