First Trust Exchange-Traded Fund III

Transcription

1 First Trust Exchange-Traded Fund III First Trust Preferred Securities and Income ETF (FPE) First Trust Institutional Preferred Securities and Income ETF (FPEI) Annual Report October 31, 2017

2 Table of Contents First Trust Exchange-Traded Fund III Annual Report October 31, 2017 Shareholder Letter Fund Performance Overview: First Trust Preferred Securities and Income ETF (FPE) First Trust Institutional Preferred Securities and Income ETF (FPEI) Notes to Fund Performance Overview Portfolio Commentary Understanding Your Fund Expenses Portfolio of Investments: First Trust Preferred Securities and Income ETF (FPE) First Trust Institutional Preferred Securities and Income ETF (FPEI) Statements of Assets and Liabilities Statements of Operations Statements of Changes in Net Assets Financial Highlights Notes to Financial Statements Report of Independent Registered Public Accounting Firm Additional Information Board of Trustees and Officers Privacy Policy Caution Regarding Forward-Looking Statements This report contains certain forward-looking statements within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements regarding the goals, beliefs, plans or current expectations of First Trust Advisors L.P. ( First Trust or the Advisor ) and/or Stonebridge Advisors LLC ( Stonebridge or the Sub-Advisor ) and their respective representatives, taking into account the information currently available to them. Forward-looking statements include all statements that do not relate solely to current or historical fact. For example, forward-looking statements include the use of words such as anticipate, estimate, intend, expect, believe, plan, may, should, would or other words that convey uncertainty of future events or outcomes. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of any series of First Trust Exchange-Traded Fund III (the Trust ) described in this report (each such series is referred to as a Fund and collectively, the Funds ) to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. When evaluating the information included in this report, you are cautioned not to place undue reliance on these forward-looking statements, which reflect the judgment of the Advisor and/or Sub-Advisor and their respective representatives only as of the date hereof. We undertake no obligation to publicly revise or update these forward-looking statements to reflect events and circumstances that arise after the date hereof. Performance and Risk Disclosure There is no assurance that any Fund described in this report will achieve its investment objective. Each Fund is subject to market risk, which is the possibility that the market values of securities owned by the Fund will decline and that the value of the Fund shares may therefore be less than what you paid for them. Accordingly, you can lose money by investing in a Fund. See Risk Considerations in the Additional Information section of this report for a discussion of certain other risks of investing in the Funds. Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. For the most recent month-end performance figures, please visit or speak with your financial advisor. Investment returns, net asset value and share price will fluctuate and Fund shares, when sold, may be worth more or less than their original cost. The Advisor may also periodically provide additional information on Fund performance on each Fund s webpage at How to Read This Report This report contains information that may help you evaluate your investment. It includes details about each Fund s portfolio and presents data and analysis that provide insight into each Fund s performance and investment approach. By reading the portfolio commentary by the portfolio management team of each Fund, you may obtain an understanding of how the market environment affected each Fund. The statistical information that follows may help you understand each Fund s performance compared to that of relevant market benchmarks. It is important to keep in mind that the opinions expressed by personnel of the Advisor or Sub-Advisor are just that: informed opinions. They should not be considered to be promises or advice. The opinions, like the statistics, cover the period through the date on the cover of this report. The material risks of investing in each Fund are spelled out in its prospectus, statement of additional information, this report and other Fund regulatory filings.

3 Shareholder Letter First Trust Exchange-Traded Fund III Annual Letter from the Chairman and CEO October 31, 2017 Dear Shareholders: Thank you for your investment in First Trust Exchange-Traded Fund III. First Trust is pleased to provide you with the annual report which contains detailed information about your investment for the 12 months ended October 31, 2017, including a market overview and a performance analysis for the period. We encourage you to read this report carefully and discuss it with your financial advisor. The U.S. bull market continued through the November 2016 election and the first nine months of the Trump presidency. During that period, November 8, 2016 (Election Day 2016) through October 31, 2017, the S&P 500 Index (the Index ) posted a total return of 22.73%, according to Bloomberg. Ten of the eleven Index sectors were up on a total return basis as well. Since the beginning of 2017 through October 31, 2017, the Index has closed its trading sessions at all-time highs on 50 occasions. Finally, as of October 31, 2017, the Index has spent the entire year in positive territory. This has only happened in 10 different years over the past seven decades. The current bull market, as measured from March 9, 2009 through October 31, 2017, is the second longest in history. While we are optimistic about the U.S. economy, we are also aware that no one can predict the future or know how markets will perform in different economic environments. We believe that one should invest for the long term and be prepared for market volatility by keeping current on your portfolio and investing goals by speaking regularly with your investment professional. It is also important to keep in mind that past performance can never guarantee future results. Thank you for giving First Trust the opportunity to be a part of your investment plan. We value our relationship with you and will continue to focus on bringing the types of investments that we believe can help you reach your financial goals. Sincerely, James A. Bowen Chairman of the Board of Trustees Chief Executive Officer of First Trust Advisors L.P. Page 1

4 Fund Performance Overview (Unaudited) First Trust Preferred Securities and Income ETF (FPE) First Trust Preferred Securities and Income ETF s (the Fund ) investment objective is to seek total return and to provide current income. Under normal market conditions, the Fund invests at least 80% of its net assets (including investment borrowings) in preferred securities ( Preferred Securities ) and income-producing debt securities ( Income Securities ). The Fund invests in securities that are traded over-the-counter or listed on an exchange. For purposes of the 80% test set forth above, securities of open-end funds, closed-end funds or other exchange-traded funds ( ETFs ) registered under the Investment Company Act of 1940, as amended, that invest primarily in Preferred Securities or Income Securities are deemed to be Preferred Securities or Income Securities. Preferred Securities held by the Fund generally pay fixed or adjustable-rate distributions to investors and have preference over common stock in the payment of distributions and the liquidation of a company s assets, but are generally junior to all forms of the company s debt, including both senior and subordinated debt. Certain of the Preferred Securities may be issued by trusts or other special purpose entities created by companies specifically for the purpose of issuing such securities. Income Securities that may be held by the Fund include corporate bonds, high yield securities (commonly referred to as junk bonds) and convertible securities. The broad category of corporate debt securities includes debt issued by U.S. and non-u.s. companies of all kinds, including those with small, mid and large capitalizations. Corporate debt may carry fixed or floating rates of interest. Performance Average Annual Cumulative Total Returns Total Returns 1 Year Ended Inception (2/11/13) Inception (2/11/13) 10/31/17 to 10/31/17 to 10/31/17 Fund Performance NAV 9.24% 5.89% 31.02% Market Price 9.01% 5.89% 30.99% Index Performance ICE BofAML Fixed Rate Preferred Securities Index (1) 6.58% 6.26% 33.17% ICE BofAML U.S. Capital Securities Index (1) 6.57% 6.06% 32.02% Blended Index (2) 6.58% 6.18% 32.68% (See Notes to Fund Performance Overview on page 8). (1) Effective October 22, 2017, the index names changed from BofA Merrill Lynch Fixed Rate Preferred Securities Index and BofA Merrill Lynch U.S. Capital Securities Index to ICE BofAML Fixed Rate Preferred Securities Index and ICE BofAML U.S. Capital Securities Index, respectively. (2) The Blended Index consists of a 50/50 blend of the ICE BofAML Fixed Rate Preferred Securities Index and the ICE BofAML U.S. Capital Securities Index. The Blended Index reflects the diverse allocation of institutional preferred and hybrid securities in the Fund s portfolio. The indexes do not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Indexes are unmanaged and an investor cannot invest directly in an index. Page 2

5 Fund Performance Overview (Unaudited) (Continued) First Trust Preferred Securities and Income ETF (FPE) (Continued) % of Total Sector Allocation Investments Financials 72.0% Utilities 6.4 Energy 6.1 Consumer Staples 3.7 Telecommunication Services 3.2 Real Estate 3.1 Industrials 2.1 Materials 1.9 Consumer Discretionary 0.9 Information Technology 0.6 Total 100.0% % of Total Top Ten Holdings Investments GMAC Capital Trust I, Series 2 2.2% Emera, Inc., Series 16-A 1.8 Enel S.p.A. 1.7 Barclays PLC 1.6 BHP Billiton Finance USA Ltd. 1.6 Enbridge Energy Partners L.P. 1.5 Credit Agricole S.A. 1.4 Intesa Sanpaolo S.p.A. 1.3 AerCap Global Aviation Trust 1.3 Royal Bank Of Scotland Group PLC 1.3 Total 15.7% % of Total Credit Rating (2) Investments A+ 0.7% A 0.7 A- 3.0 BBB+ 6.3 BBB 14.5 BBB BB BB 8.2 BB- 6.3 B+ 4.1 B 0.1 Not Rated 5.6 Total 100.0% % of Total Country Exposure Investments United States 55.0% France 9.2 United Kingdom 9.1 Italy 4.4 Canada 4.3 Australia 3.7 Netherlands 3.2 Bermuda 2.3 Switzerland 2.2 Cayman Islands 1.9 Spain 1.2 Mexico 0.9 Japan 0.8 Ireland 0.7 Chile 0.4 Denmark 0.3 Belgium 0.3 Jersey 0.1 Brazil 0.0* Total 100.0% * Amount is less than 0.1%. (2) The credit quality and ratings information presented above reflects the ratings assigned by one or more nationally recognized statistical rating organizations (NRSROs), including Standard & Poor s Ratings Group, a division of the McGraw-Hill Companies, Inc., Moody s Investors Service, Inc., Fitch Ratings or a comparably rated NRSRO. For situations in which a security is rated by more than one NRSRO and the ratings are not equivalent, the highest ratings are used. Sub-investment grade ratings are those rated BB+/Ba1 or lower. Investment grade ratings are those rated BBB-/Baa3 or higher. The credit ratings shown relate to the creditworthiness of the issuers of the underlying securities in the Fund, and not to the Fund or its shares. Credit ratings are subject to change. Page 3

6 Fund Performance Overview (Unaudited) (Continued) First Trust Preferred Securities and Income ETF (FPE) (Continued) $14,000 $12,000 $10,000 $8,000 Performance of a $10,000 Initial Investment February 11, October 31, /11/13 4/30/13 10/31/13 4/30/14 10/31/14 4/30/15 10/31/15 4/30/16 10/31/16 4/30/17 10/31/17 First Trust Preferred Securities and Income ETF ICE BofAML Fixed Rate Preferred Securities Index ICE BofAML U.S. Capital Securities Index Blended Index (1) $13,317 $13,267 $13,203 $13,103 Performance figures assume reinvest - ment of all distributions and do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. An index is a statistical composite that tracks a specified financial market or sector. Unlike the Fund, the indices do not actually hold a portfolio of securities and therefore do not incur the expenses incurred by the Fund. These expenses negatively impact the performance of the Fund. The Fund s past performance does not predict future performance. Frequency Distribution of Discounts and Premiums Bid/Ask Midpoint vs. NAV through October 31, 2017 The following Frequency Distribution of Discounts and Premiums charts are provided to show the frequency at which the bid/ask midpoint price for the Fund was at a discount or premium to the daily NAV. The following tables are for comparative purposes only and represent the period February 12, 2013 (commencement of trading) through October 31, Shareholders may pay more than NAV when they buy Fund shares and receive less than NAV when they sell those shares because shares are bought and sold at current market price. Data presented represents past performance and cannot be used to predict future results. Number of Days Bid/Ask Midpoint At/Above NAV For the Period 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00% 2/12/13-10/31/ /1/13-10/31/ /1/14-10/31/ /1/15-10/31/ /1/16-10/31/ Number of Days Bid/Ask Midpoint Below NAV For the Period 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00% 2/12/13-10/31/ /1/13-10/31/ /1/14-10/31/ /1/15-10/31/ /1/16-10/31/ (1) The Blended Index consists of a 50/50 blend of the ICE BofAML Fixed Rate Preferred Securities Index and the ICE BofAML U.S. Capital Securities Index. The Blended Index reflects the diverse allocation of institutional preferred and hybrid securities in the Fund s portfolio. The indexes do not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Indexes are unmanaged and an investor cannot invest directly in an index. Page 4

7 Fund Performance Overview (Unaudited) First Trust Institutional Preferred Securities and Income ETF (FPEI) First Trust Institutional Preferred Securities and Income ETF s (the Fund ) investment objective is to seek total return and to provide current income. Under normal market conditions, the Fund invests at least 80% of its net assets (including investment borrowings) in institutional preferred securities ( Preferred Securities ) and income-producing debt securities ( Income Securities ). Preferred securities are a type of equity security that have preference over common stock in the payment of distributions and the liquidation of a company s assets, but are generally junior to all forms of the company's debt, including both senior and subordinated debt. The Fund s investments in preferred securities will primarily be in institutional preferred securities. Institutional preferred securities are targeted to institutional, rather than retail, investors, are generally traded over-the-counter and may also be known as $1,000 par preferred securities. They are typically issued in large, institutional lot sizes by U.S. and non-u.s. financial services companies and other companies. While all income-producing debt securities will be categorized as Income Securities for purposes of the 80% test above, the Income Securities in which the Fund intends to invest as part of its principal investment strategy include hybrid capital securities, contingent capital securities, U.S. and non-u.s. corporate bonds and convertible securities. Performance Cumulative Total Returns Inception (8/22/17) to 10/31/17 Fund Performance NAV 2.00% Market Price 2.05% Index Performance ICE BofAML US Investment Grade Institutional Capital Securities Index 1.25% (See Notes to Fund Performance Overview on page 8). Page 5

8 Fund Performance Overview (Unaudited) (Continued) First Trust Institutional Preferred Securities and Income ETF (FPEI) (Continued) % of Total Sector Allocation Investments Financials 66.7% Energy 12.5 Utilities 9.7 Materials 3.9 Consumer Discretionary 3.5 Telecommunication Services 1.9 Industrials 1.8 Total 100.0% % of Total Credit Rating (1) Investments A 1.7% A- 8.2 BBB+ 2.6 BBB 16.7 BBB BB BB 4.7 BB- 7.8 B+ 1.8 Not Rated 0.8 Total 100.0% % of Total Top Ten Holdings Investments Mitsui Sumitomo Insurance Co., Ltd. 4.3% Enel S.p.A. 4.1 Transcanada Trust, Series 16-A 4.1 Enbridge, Inc., Series 16-A 4.0 BHP Billiton Finance USA Ltd. 3.9 Emera, Inc., Series 16-A 3.8 Metlife, Inc. 3.8 Wells Fargo & Co., Series U 3.7 JPMorgan Chase & Co., Series R 3.7 Citigroup, Inc., Series P 3.7 Total 39.1% % of Total Country Exposure Investments United States 45.8% United Kingdom 13.2 Canada 12.0 Italy 7.8 France 6.7 Japan 4.3 Australia 3.9 Switzerland 2.4 Bermuda 2.0 Netherlands 1.9 Total 100.0% (1) The credit quality and ratings information presented above reflects the ratings assigned by one or more nationally recognized statistical rating organizations (NRSROs), including Standard & Poor s Ratings Group, a division of the McGraw-Hill Companies, Inc., Moody s Investors Service, Inc., Fitch Ratings or a comparably rated NRSRO. For situations in which a security is rated by more than one NRSRO and the ratings are not equivalent, the highest ratings are used. Sub-investment grade ratings are those rated BB+/Ba1 or lower. Investment grade ratings are those rated BBB-/Baa3 or higher. The credit ratings shown relate to the creditworthiness of the issuers of the underlying securities in the Fund, and not to the Fund or its shares. Credit ratings are subject to change. Page 6

9 Fund Performance Overview (Unaudited) (Continued) First Trust Institutional Preferred Securities and Income ETF (FPEI) (Continued) $10,500 $10,000 $9,500 8/22/17 Performance of a $10,000 Initial Investment August 22, October 31, /31/17 First Trust Institutional Preferred Securities and Income ETF ICE BofAML US Investment Grade Institutional Capital Securities Index $10,200 $10,125 Performance figures assume reinvest - ment of all distributions and do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. An index is a statistical composite that tracks a specified financial market or sector. Unlike the Fund, the index does not actually hold a portfolio of securities and therefore does not incur the expenses incurred by the Fund. These expenses negatively impact the performance of the Fund. The Fund s past performance does not predict future performance. Frequency Distribution of Discounts and Premiums Bid/Ask Midpoint vs. NAV through October 31, 2017 The following Frequency Distribution of Discounts and Premiums charts are provided to show the frequency at which the bid/ask midpoint price for the Fund was at a discount or premium to the daily NAV. The following tables are for comparative purposes only and represent the period August 23, 2017 (commencement of trading) through October 31, Shareholders may pay more than NAV when they buy Fund shares and receive less than NAV when they sell those shares because shares are bought and sold at current market price. Data presented represents past performance and cannot be used to predict future results. Number of Days Bid/Ask Midpoint At/Above NAV For the Period 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00% 8/23/17-10/31/ Number of Days Bid/Ask Midpoint Below NAV For the Period 0.00%-0.49% 0.50%-0.99% 1.00%-1.99% >=2.00% 8/23/17-10/31/ Page 7

10 Notes to Funds Performance Overview (Unaudited) Total returns for the periods since inception are calculated from the inception date of each Fund. Average Annual Total Returns represent the average annual change in value of an investment over the periods indicated. Cumulative Total Returns represent the total change in value of an investment over the periods indicated. Each Fund s per share net asset value ( NAV ) is the value of one share of the Fund and is computed by dividing the value of all assets of the Fund (including accrued interest and dividends), less all liabilities (including accrued expenses and dividends declared but unpaid), by the total number of outstanding shares. The price used to calculate market return ( Market Price ) is determined by using the midpoint between the highest bid and the lowest offer on the stock exchange on which shares of the Fund are listed for trading as of the time that the Fund s NAV is calculated. Since shares of each Fund did not trade in the secondary market until after their inception, for the period from inception to the first day of secondary market trading in shares of the Fund, the NAV of each Fund is used as a proxy for the secondary market trading price to calculate market returns. NAV and market returns assume that all distributions have been reinvested in each Fund at NAV and Market Price, respectively. An index is a statistical composite that tracks a specified financial market or sector. Unlike each Fund, the indices do not actually hold a portfolio of securities and therefore do not incur the expenses incurred by each Fund. These expenses negatively impact the performance of each Fund. Also, market returns do not include brokerage commissions that may be payable on secondary market transactions. If brokerage commissions were included, market returns would be lower. The total returns presented reflect the reinvestment of dividends on securities in the indices. The returns presented do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption or sale of Fund shares. The investment return and principal value of shares of each Fund will vary with changes in market conditions. Shares of each Fund may be worth more or less than their original cost when they are redeemed or sold in the market. Each Fund s past performance is no guarantee of future performance. Page 8

11 Market Portfolio Overview Commentary First Trust Exchange-Traded Fund III Annual Report October 31, 2017 (Unaudited) Advisor First Trust Advisors L.P. ( First Trust ) is the investment advisor to the First Trust Preferred Securities and Income ETF and the First Trust Institutional Preferred Securities and Income ETF (each a Fund and collectively the Funds ). First Trust is responsible for the ongoing monitoring of the Funds investment portfolios, managing the Funds business affairs and providing certain administrative services necessary for the management of the Funds. Sub-Advisor Stonebridge Advisors LLC Stonebridge Advisors LLC ( Stonebridge or the Sub-Advisor ) is the investment sub-advisor to the Funds and is a registered investment advisor based in Wilton, Connecticut. Stonebridge specializes in the management of preferred and hybrid securities. Portfolio Management Team Scott T. Fleming President and Chief Investment Officer Robert Wolf Senior Vice President, Senior Portfolio Manager Danielle Salters, CFA Vice President, Portfolio Manager and Credit Analyst Commentary First Trust Preferred Securities and Income ETF (FPE) Market Recap The fiscal year ended October 31, 2017 was a period of solid returns for the preferred and hybrid securities markets. The period began with substantial volatility following an increase in interest rates in the fourth quarter of 2016 and from the unexpected victory of Donald Trump in the U.S. Presidential election and the Republican success at keeping control of the U.S. Congress. Higher rates were also supported by improving economic and employment data, which allowed the Federal Reserve (the Fed ) to increase short-term interest rates by 0.25% three times during the period. However, risk assets recovered and performed well throughout the last three quarters of the period due to stabilizing long-term interest rates, a flattening yield curve, and significant spread tightening. Contingent capital securities ( CoCos ) were the best performing part of the preferred and hybrid securities markets during the period, returning 16.78%. We believe this was due to the improvement in credit quality of European banks (largest issuers of CoCos), attractive yields and structures compared to U.S. bank tier 1 capital securities, and the increasing investor comfort with the securities and more stable investor base. After initial weakness during the period, the retail preferred market was pushed higher by inflows into passive preferred exchange-traded funds ( ETFs ), limited new issuance, and stable rates, which were positive for the fixed for life structures that make up the majority of the retail market. For the fiscal year, the retail market earned 6.58% while the institutional market earned 6.57%, according to the ICE BofAML Fixed Rate Preferred Securities Index ( P0P1 ) and the ICE BofAML U.S. Capital Securities Index ( C0CS ), respectively. Performance Analysis For the fiscal year ended October 31, 2017, the net asset value ( NAV ) and market price total returns for the Fund were 9.24% and 9.01%, respectively. This compares to a total return of 6.58% for the Fund s benchmark, which is a 50/50 blend of P0P1 and C0CS. The Fund benefited from yield spread tightening and a flattening Treasury yield curve, as the front end of the Treasury yield curve was pushed higher by the Fed, which resulted in improvement in both fixed-to-floats and floating-rate preferred securities. The largest positive contributors to the Fund s outperformance relative to the benchmark during the year included security selection and an overweight to CoCos and floating-rate securities. Outperformance through security selection was driven by increasing exposure to institutional securities with attractive yields and structures that appreciated in value as yield spreads compressed. The Fund also benefited through exposure to CoCos, which were not part of the benchmark index. CoCos increased in value during the year due to several factors, including the improvement in credit quality of European banks, attractive yields and structures compared to U.S. bank tier 1 capital securities, and an increasing investor base. Floating-rate securities were also a positive contributor to relative performance as the front end of the treasury curve and The London Interbank Offered Rate ( LIBOR ) reset higher. Market and Fund Outlook The strong macro-economic backdrop, strong corporate earnings and solid creditworthiness, particularly within financials, continue to support a risk-on environment, in our opinion. Stable to gradually increasing rates, moderate issuance, and the continued demand for yield continue to be positive for the preferred and hybrid securities markets. However, we believe strong performance across equity and credit markets and increased economic optimism has stretched valuations of new issuance in some cases, which could become problematic if interest rates or supply increases. Recently, weaker security structures have come to market, but the deals were many times oversubscribed, supported by investor demand for yield and some buyers that are indiscriminate about pricing, in the form of Page 9

12 Portfolio Commentary (Continued) Page 10 First Trust Exchange-Traded Fund III Annual Report October 31, 2017 (Unaudited) passive ETFs, taking up a larger share of markets and deals. We believe this could put pressure on distributions if higher yielding legacy securities continue to be redeemed and replaced by lower yielding securities. We continue to believe that the yield curve is likely to remain flat, as short-term rates are likely to increase and may push long term rates higher. We have long anticipated, and positioned for, a rising rate environment, and we continue to hold the view that this process will be gradual. We believe U.S. fiscal policy and potential tax and regulatory changes have the potential to boost economic growth, but we also believe this impact is likely to be muted and slow given political uncertainty and the likelihood that any changes will likely be phased in over time. We continue to focus on protecting the principal of our investors and, as such, we believe it is prudent to protect investors against a potential rise in interest rates through actively managing interest rate risk. First Trust Institutional Preferred Securities and Income ETF (FPEI) Market Recap The fiscal year ended October 31, 2017 was a period of solid returns for the preferred and hybrid securities markets. Since the inception of the Fund on August 22, 2017, the institutional market outperformed the retail market, earning 1.25%, according to the ICE BofAML US Investment Grade Institutional Capital Securities Index ( CIPS ), whereas the retail market, as measured by the ICE BofAML Core Plus Fixed Rate Preferred Securities Index ( P0P4 ), returned only 0.67%. We believe the outperformance of the institutional market was partially driven by an uptick in issuance from U.S. and European issuers. The flattening yield curve and significant spread tightening experienced by the preferred and hybrid securities markets throughout 2017 created attractive conditions for issuers, as newer deals launched with significantly smaller back-end spreads and yields. This created a strong technical bid in the institutional market for structurally superior legacy securities, causing the whole market to trade higher. Contingent capital securities ( CoCos ) were the best performing part of the institutional preferred and hybrid securities markets during the period, returning 3.78%. We believe this was due to the improvement in credit quality of European banks (the largest issuers of CoCos), attractive yields and structures compared to U.S. bank tier 1 capital securities, the increasing investor comfort with the securities and more stable investor base. Performance Analysis For the period from the Fund s inception on August 22, 2017, through October 31, 2017, the net asset value ( NAV ) and market price total returns for the Fund were 2.00% and 2.05%, respectively. This compares to a total return of 1.25% for the Fund s benchmark, CIPS. The Fund benefited from yield spread tightening and a flattening Treasury yield curve, as the front end of the Treasury yield curve was pushed higher by the Federal Reserve (the Fed ), which resulted in improvement in both fixed-to-floats and floating-rate preferred securities. The largest positive contributors to the Fund s outperformance relative to the benchmark during the period included security selection, an overweight to CoCos, and an underweight to Japanese preferred and hybrid preferred securities. The Fund s weighting in CoCos, which are not held in the benchmark, was the single largest reason for outperformance relative to the benchmark. As spreads tightened in fixed-income markets, CoCos continued to offer some of the most attractive yields and structures in the institutional market. Additionally, security selection within U.S. Banks and Utilities contributed to outperformance. Finally, the Fund benefited relative to the benchmark from its underweight in Japanese securities. These securities underperformed due to rich valuations entering the quarter. One of the biggest detractors from relative performance was the Fund s security selection and overweight to property and casualty insurance companies, which sold off in September 2017 due to hurricane fears. The Fund s security selection within the energy space hurt relative performance as well. Market and Fund Outlook The strong macro-economic backdrop, strong corporate earnings and solid creditworthiness, particularly within financials, continue to support a risk-on environment, in our opinion. Stable to gradually increasing rates, moderate issuance, and the continued demand for yield continue to be positive for the preferred and hybrid securities markets. However, we believe strong performance across equity and credit markets and increased economic optimism has stretched valuations of new issuance in some cases, which could become problematic if interest rates or supply increases. Recently, weaker security structures have come to market, but the deals were many times oversubscribed, supported by investor demand for yield and some buyers that are indiscriminate about pricing, in the form of passive ETFs, taking up a larger share of markets and deals. We believe this could put pressure on distributions if higher yielding legacy securities continue to be redeemed and replaced by lower yielding securities. We continue to believe that the yield curve is likely to remain flat, as short-term rates are likely to increase and may push long term rates higher. We have long anticipated, and positioned for, a rising rate environment, and we continue to hold the view that this process will be gradual. We believe U.S. fiscal policy and potential tax and regulatory changes have the potential to boost economic growth, but we also believe this impact is likely to be muted and slow given political uncertainty and the likelihood that any changes will likely be phased in over time. We continue to focus on protecting the principal of our investors and, as such, we believe it is prudent to protect investors against a potential rise in interest rates through actively managing interest rate risk.

13 First Trust Exchange-Traded Fund III Understanding Your Fund Expenses October 31, 2017 (Unaudited) As a shareholder of First Trust Preferred Securities and Income ETF or First Trust Institutional Preferred Securities and Income ETF (each a Fund and collectively, the Funds ), you incur two types of costs: (1) transaction costs; and (2) ongoing costs, including management fees, distribution and/or service fees, if any, and other Fund expenses. This Example is intended to help you understand your ongoing costs of investing in the Funds and to compare these costs with the ongoing costs of investing in other funds. The Example is based on an investment of $1,000 invested at the beginning of the period (or since inception) and held through the sixmonth (or shorter) period ended October 31, Actual Expenses The first line in the following table provides information about actual account values and actual expenses. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled Expenses Paid During the Six-Month Period to estimate the expenses you paid on your account during this six-month period. Hypothetical Example for Comparison Purposes The second line in the following table provides information about hypothetical account values and hypothetical expenses based on each Fund s actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not each Fund s actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Funds and other funds. To do so, compare this 5% hypothetical example with the 5% hypothetical examples that appear in the shareholder reports of the other funds. Please note that the expenses shown in the table are meant to highlight your ongoing costs only and do not reflect any transactional costs such as brokerage commissions. Therefore, the second line in the table is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different funds. In addition, if these transactional costs were included, your costs would have been higher. Annualized Expense Ratio Expenses Paid Beginning Ending Based on the During the Account Value Account Value Six-Month Six-Month May 1, 2017 October 31, 2017 Period Period (a) First Trust Preferred Securities and Income ETF (FPE) Actual $1, $1, % $4.39 Hypothetical (5% return before expenses) $1, $1, % $4.33 Annualized Expenses Paid Expense Ratio During the Period Beginning Ending Based on the August 22, 2017 (b) Account Value Account Value Number of Days to August 22, 2017 October 31, 2017 in the Period October 31, 2017 (c) First Trust Institutional Preferred Securities and Income ETF (FPEI) Actual $1, $1, % $1.65 Hypothetical (5% return before expenses) $1, $1, % $4.33 (a) Expenses are equal to the annualized expense ratio as indicated in the table multiplied by the average account value over the period (May 1, 2017 through October 31, 2017), multiplied by 184/365 (to reflect the one-half year period). (b) Inception date. (c) Actual expenses are equal to the annualized expense ratio as indicated in the table multiplied by the average account value over the period (August 22, 2017 through October 31, 2017), multiplied by 70/365. Hypothetical expenses are assumed for the most recent half-year period. Page 11

14 First Trust Preferred Securities and Income ETF (FPE) Portfolio of Investments October 31, 2017 Stated Stated Shares Description Rate Maturity Value $25 PAR PREFERRED SECURITIES % Banks - 7.9% 279,161 Banc Of California, Inc., Series E % (a) $ 7,824, ,798 Bank of America Corp., Series CC % (a) 5,381, ,673 Citigroup Capital XIII, 3 Mo. LIBOR % (b) % 10/30/40 18,609,579 81,743 Citigroup, Inc., Series S % (a) 2,212, ,933 Fifth Third Bancorp, Series I (c) % (a) 13,217, ,850 FNB Corp. (c) % (a) 4,431,122 2,472,431 GMAC Capital Trust I, Series 2, 3 Mo. LIBOR % (b) % 02/15/40 64,926, ,423 Huntington Bancshares, Inc., Series D % (a) 20,581, ,814 KeyCorp, Series E (c) % (a) 18,150, ,503 People s United Financial, Inc., Series A (c) % (a) 21,770, ,349 PNC Financial Services Group, Inc., Series P (c) % (a) 6,077, ,281 Royal Bank of Scotland Group PLC, Series S % (a) 7,727, ,178 Synovus Financial Corp., Series C (c) % (a) 14,839, ,575 Valley National Bancorp, Series A (c) % (a) 4,478, ,894 Valley National Bancorp, Series B (c) % (a) 3,957, ,227 Wells Fargo & Co., Series Q (c) % (a) 3,601,863 87,688 Wells Fargo & Co., Series W % (a) 2,259,720 55,237 Western Allliance Bancorp % 07/01/56 1,458, ,679 Wintrust Financial Corp., Series D (c) % (a) 12,670, ,834 Zions Bancorporation, Series G (c) % (a) 4,427, ,605,167 Capital Markets - 5.6% 700,540 Apollo Investment Corp % 07/15/43 18,101, ,404 BGC Partners, Inc % 06/15/42 5,252,384 1,302,831 Goldman Sachs Group, Inc., Series K (c) % (a) 37,417,306 1,063,293 Morgan Stanley, Series E (c) % (a) 30,782,332 1,331,011 Morgan Stanley, Series F (c) % (a) 38,000, ,748 Morgan Stanley, Series I (c) % (a) 9,484, ,672 Morgan Stanley, Series K (c) % (a) 6,120, ,272 Solar Capital Ltd % 11/15/42 5,183, ,374 State Street Corp., Series G (c) % (a) 11,488, ,396 Stifel Financial Corp., Series A % (a) 6,109, ,940,712 Consumer Finance - 0.1% 89,758 Capital One Financial Corp., Series D % (a) 2,427,954 Diversified Financial Services - 0.6% 773,064 KKR Financial Holdings LLC, Series A % (a) 19,612,634 Diversified Telecommunication Services - 1.3% 797,844 Qwest Corp % 10/01/54 20,512, ,220 Qwest Corp % 09/01/56 6,368, ,135 Qwest Corp % 06/15/57 12,498,443 39,379,567 Electric Utilities - 0.3% 82,877 SCE Trust V, Series K (c) % (a) 2,273, ,679 Southern (The) Co % 10/15/75 5,495,259 7,768,575 Equity Real Estate Investment Trusts - 3.0% 264,705 American Homes 4 Rent, Series D % (a) 7,104, ,147 American Homes 4 Rent, Series E % (a) 19,943, ,549 Colony NorthStar, Inc., Series J % (a) 4,216, ,656 Colony NorthStar, Inc., Series E % (a) 8,198,712 Page 12 See Notes to Financial Statements

15 First Trust Preferred Securities and Income ETF (FPE) Portfolio of Investments (Continued) October 31, 2017 Stated Stated Shares Description Rate Maturity Value $25 PAR PREFERRED SECURITIES (Continued) Equity Real Estate Investment Trusts (Continued) 301,385 EPR Properties, Series F % (a) $ 7,615, ,828 Farmland Partners, Inc., Series B (d) % (a) 6,606, ,851 Global Net Lease, Inc., Series A % (a) 6,614,745 89,274 Taubman Centers, Inc., Series J % (a) 2,249, ,888 Urstadt Biddle Properties, Inc., Series H % (a) 4,198, ,598 VEREIT, Inc., Series F % (a) 24,894,901 91,643,022 Food Products - 1.2% 546,435 CHS, Inc., Series 2 (c) % (a) 15,119, ,782 CHS, Inc., Series 3 (c) % (a) 15,418, ,786 CHS, Inc., Series % (a) 5,867,119 36,405,524 Insurance - 5.0% 30,045 Aegon N.V % (a) 778, ,558 Aegon N.V % 02/15/42 25,769, ,423 AmTrust Financial Services, Inc % 06/15/55 3,700, ,943 AmTrust Financial Services, Inc % 09/15/55 5,763,624 54,680 AmTrust Financial Services, Inc., Series E % (a) 1,405, ,313 AmTrust Financial Services, Inc., Series F % (a) 3,495,330 48,051 Aspen Insurance Holdings Ltd % (a) 1,217, ,279 Aspen Insurance Holdings Ltd. (c) % (a) 16,117, ,203 Delphi Financial Group, Inc., 3 Mo. LIBOR +3.19% (b) (e) % 05/15/37 9,488, ,563 Global Indemnity Ltd % 08/15/45 12,612, ,412 Global Indemnity Ltd % 04/15/47 10,763, ,250 National General Holdings Corp % 09/15/55 7,850, ,565 National General Holdings Corp., Series C % (a) 2,907, ,056 PartnerRe Ltd., Series H % (a) 13,891, ,204 Phoenix Cos., Inc % 01/15/32 2,774, ,327 Reinsurance Group of America, Inc. (c) % 06/15/56 25,056, ,181 Validus Holdings, Ltd., Series B % (a) 5,210, ,857 WR Berkley Corp % 06/01/56 3,415, ,217,978 Internet Software & Services - 0.6% 639,832 ebay, Inc % 02/01/56 17,326,651 Mortgage Real Estate Investment Trusts - 1.3% 259,032 AGNC Investment Corp., Series C (c) % (a) 6,929, ,865 Annaly Capital Management, Inc., Series F (c) % (a) 11,718, ,277 Invesco Mortgage Capital, Inc., Series B (c) % (a) 4,121, ,005 MFA Financial, Inc % 04/15/42 9,827, ,893 Two Harbors Investment, Corp., Series B (c) % (a) 6,876,198 39,472,273 Multi-Utilities - 0.7% 364,646 Integrys Holding, Inc. (c) % 08/01/73 10,324, ,411 Just Energy Group, Inc., Series A (c) % (a) 11,632,686 21,956,726 Oil, Gas & Consumable Fuels - 0.5% 164,265 NuStar Energy L.P., Series A (c) % (a) 4,311, ,383 NuStar Logistics L.P. (c) % 01/15/43 11,363,861 15,675,817 Thrifts & Mortgage Finance - 1.0% 1,047,748 New York Community Bancorp, Inc., Series A (c) % (a) 29,263,602 See Notes to Financial Statements Page 13

16 First Trust Preferred Securities and Income ETF (FPE) Portfolio of Investments (Continued) October 31, 2017 Stated Stated Shares Description Rate Maturity Value $25 PAR PREFERRED SECURITIES (Continued) Wireless Telecommunication Services - 0.9% 230,199 United States Cellular Corp % 12/01/63 $ 6,132, ,426 United States Cellular Corp % 12/01/64 21,754,331 27,886,832 Total $25 Par Preferred Securities ,583,034 (Cost $886,392,126) $100 PAR PREFERRED SECURITIES - 1.1% Banks - 0.3% 21,135 Agribank FCB (c) (e) % (a) 2,342,022 13,800 CoBank ACB, Series F (c) (f) % (a) 1,490,400 11,172 CoBank ACB, Series G % (a) 1,142,476 12,197 CoBank ACB, Series H (c) % (a) 1,306,985 34,840 Farm Credit Bank Of Texas (c) (g) % (a) 3,841,110 10,122,993 Consumer Finance - 0.8% 346,818 SLM Corp., Series B, 3 Mo. LIBOR % (b) % (a) 23,347,788 Total $100 Par Preferred Securities ,470,781 (Cost $27,968,764) $1,000 PAR PREFERRED SECURITIES - 2.5% Banks - 1.0% 20,000 Farm Credit Bank Of Texas, Series 1 (g) % (a) 24,450,000 4,556 Sovereign Real Estate Investment Trust (g) % (a) 5,712,085 30,162,085 Consumer Finance - 0.1% 2,500 Compeer Financial ACA (c) (g) % (a) 2,672,812 Diversified Financial Services - 0.3% 10,000 Kinder Morgan GP, Inc., 3 Mo. LIBOR % (b) (g) % 08/18/57 9,394,375 Insurance - 1.1% 33,450 XLIT Ltd., Series D, 3 Mo. LIBOR % (b) % (a) 31,923,844 Total $1,000 Par Preferred Securities ,153,116 (Cost $70,522,223) Par Stated Stated Amount Description Rate Maturity Value CAPITAL PREFERRED SECURITIES % Automobiles - 0.9% $ 26,300,000 General Motors Financial Co., Inc., Series A (c) % (a) 27,549,250 Banks % 15,364,000 Australia & New Zealand Banking Group Ltd. (c) (f) (h) % (a) 17,690,110 22,000,000 Banco Bilbao Vizcaya Argentaria S.A. (c) (h) % (a) 22,773,630 1,000,000 Banco do Brasil S.A. (c) (f) (h) % (a) 1,100,000 10,600,000 Banco Mercantil del Norte S.A. (c) (f) (h) % 10/04/31 10,812,000 4,900,000 Banco Mercantil del Norte S.A. (c) (f) (h) % (a) 5,157,250 8,500,000 Banco Mercantil del Norte S.A. (c) (f) (h) % (a) 9,265,000 13,800,000 Banco Santander S.A. (c) (h) % (a) 14,383,740 6,725,000 Bank of America Corp., Series AA (c) % (a) 7,515,187 17,000,000 Bank of America Corp., Series DD (c) % (a) 19,410,260 10,000,000 Bank of America Corp., Series K (c) % (a) 10,137,500 14,902,000 Bank of America Corp., Series M (c) % (a) 15,391,531 8,000,000 Bank of America Corp., Series X (c) % (a) 8,920,000 Page 14 See Notes to Financial Statements