Diversified Currency Income Fund (I)¹

A Word On The Markets  as of Mar 31, 2012

Stronger-than-forecasted economic figures in the United States drove a rally in U.S. equity and high-yield debt markets. GDP growth that exceeded expectations coupled with improving employment statistics pushed yields higher on longer-dated U.S. Treasury bonds. Further pushing longer-dated yields higher was an indication from the Federal Reserve that additional quantitative easing may not be needed to stimulate the U.S. economy.

Unprecedented long-term refinancing operation (LTRO) measures used by the European Central Bank (ECB) to inject liquidity into the European banking systems helped bring a semblance of calm to the eurozone sovereign debt crisis. With over a trillion euros injected into the market, the euro depreciated against most Central and Eastern European countries. Greece was able to engineer the largest sovereign debt swap ever by enforcing retroactively inserted collective action clauses into its Greek law bonds. Yields on long-term Spanish debt rose, as the recently elected administration announced that the country would sharply miss its budget deficit target.

The Bank of Japan continued its asset buying program and announced an explicit consumer price inflation target of one percent. The yen depreciated versus the U.S. dollar in response. Most Latin American and Asian currencies appreciated versus the dollar during the period, as the liquidity measures from developed world central banks helped assuage fears of another sharp decline in global economic growth.

The Middle East and North Africa continued to be a source of event risk, as sanctions were levied against Iran, Syria headed towards outright civil war and the Mali government was overthrown via coup.

Performance Summary 

For the quarter ended March 31, 2012, Diversified Currency Income Fund outperformed its benchmark, the Barclays Capital Global Ex-USD Benchmark Currency (Trade-Weighted) Index Index⁴at net asset value .

• Fueled by ample liquidity from developed world central banks, investors favored assets prices during the quarter and most foreign currencies appreciated versus the U.S. dollar.
• The Fund's investments in Asia and Latin America contributed positively to performance. Nearly every position in Asia appreciated versus the dollar and every position in Latin America gained versus the dollar, which made the region the top performer. Further, all three currencies in the Dollar Bloc, Australia, Canada and New Zealand appreciated versus the dollar.
• Most of the Fund's investments in currencies in Africa and the Middle East appreciated versus the dollar. Additionally, positions in precious metals, gold and platinum also rose in value during the period.
• Currencies in Scandinavia fared well versus the euro and contributed positively to performance. In Central and Eastern Europe, most currencies also appreciated versus the euro.
• Sovereign bill positions in Sri Lanka detracted from performance.

Contributors 

Contributors to performance during the first quarter:

• Spurred by better-than-expected economic figures in the United States, the Mexican peso appreciated versus the U.S. dollar and was the largest contributing position to performance.
• Stronger-than-expected economic data in the United States and higher oil prices drove the Canadian dollar higher versus the U.S. dollar and contributed positively to performance.
• Signs of strong economic growth in the Philippines led to an appreciation of the Phillippine peso against the dollar, which contributed to positive fund performance.
• The Polish zloty rallied strongly against the euro during the period, which contributed positively to Fund performance. Favorable economic data further solidified Poland as a potentially attractive emerging-market economy in Europe.

Detractors 

Detractors to performance during the first quarter:

• Faced with declining central bank reserves, Sri Lanka depegged the rupee during the quarter, which led to a sharp depreciation against the dollar. The Fund's investment in Sri Lankan sovereign bills detracted from performance as a result.
• The Ghanaian Central bank was unable to control a steady depreciation of the cedi during the period, and the Fund's position detracted from performance.
• While many Central and Eastern European and Scandinavian currencies appreciated versus the euro during the period, the Fund's cross-hedge, being short the euro against these currencies, was a drag on performance, as the euro appreciated versus the dollar during the period.

Investment Outlook And Fund Positioning 

Management expects the Federal Reserve to continue to maintain a zero interest-rate policy, manipulate the yield curve and permit headline inflation to run close to current levels for the foreseeable future. We believe these actions enforce negative real interest rates in the U.S. and may ultimately lead to dollar weakness versus many foreign currencies.

We believe the European Central Bank will continue its policy of flooding the market with liquidity whenever there is a flare up in the eurozone sovereign debt crisis. These measures would likely expand the central bank's balance sheet, which could induce monetary union-wide inflation as a means to address the crisis.

Management remains optimistic that investments in developed, emerging and frontier market currencies via currency forwards or short-duration sovereign bills may provide investors with a valuable means by which to try and avoid potentially negative real interest rates in the United States.

The views expressed in this report are those of portfolio manager(s) and are current only through the date stated at the top of this page. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. This commentary may contain statements that are not historical facts, referred to as "forward looking statements". The Fund's actual future results may differ significantly from those stated in any forward-looking statement, depending on factors such as changes in securities or financial markets or general economic conditions, the volume of sales and purchases of Fund shares, the continuation of investment advisory, administrative and service contracts, and other risks discussed from time to time in the Fund's filings with the Securities and Exchange Commission.

Fund primarily invests in an affiliated investment company (Portfolio) with the same objective(s) and policies as the Fund and may also invest directly. References to investments are to the Portfolio's holdings. Portfolio profile subject to change due to active management. Percentages may not total 100% due to rounding.

About Risk 

Investments in foreign instruments or currencies can involve greater risk and volatility than U.S. investments because of adverse market, economic, political, regulatory, geopolitical or other conditions. In emerging or frontier countries, these risks may be more significant. An imbalance in supply and demand in the income market may result in valuation uncertainties and greater volatility, less liquidity, widening credit spreads and a lack of price transparency in the market. Investments in income securities may be affected by changes in the creditworthiness of the issuer and are subject to the risk of non–payment of principal and interest. The value of income securities also may decline because of real or perceived concerns about the issuer's ability to make principal and interest payments. Derivatives instruments can be used to take both long and short positions, be highly volatile, result in economic leverage (which can magnify losses), and involve risks in addition to the risks of the underlying instrument on which the derivative is based, such as counterparty, correlation and liquidity risk. If a counterparty is unable to honor its commitments, the value of Fund shares may decline and/or the Fund could experience delays in the return of collateral or other assets held by the counterparty. The value of commodities investments will generally be affected by overall market movements and factors specific to a particular industry or commodity, including weather, embargoes, tariffs, or health, political, international and regulatory developments. As interest rates rise, the value of certain income investments is likely to decline. Because the Fund investments may be concentrated in a particular geographic region or country, the Fund share value may fluctuate more than that of a less concentrated fund. Investments rated below investment grade (typically referred to as "junk") are generally subject to greater price volatility and illiquidity than higher rated investments. No Fund is a complete investment program and you may lose money investing in a Fund. The Fund may engage in other investment practices that may involve additional risks and you should review the Fund prospectus for a complete description.

No attribution information is available.

Fund primarily invests in an affiliated investment company (Portfolio) with the same objective(s) and policies as the Fund and may also invest directly. References to investments are to the Portfolio's holdings. Portfolio profile subject to change due to active management. Percentages may not total 100% due to rounding.

About Risk 

Investments in foreign instruments or currencies can involve greater risk and volatility than U.S. investments because of adverse market, economic, political, regulatory, geopolitical or other conditions. In emerging or frontier countries, these risks may be more significant. An imbalance in supply and demand in the income market may result in valuation uncertainties and greater volatility, less liquidity, widening credit spreads and a lack of price transparency in the market. Investments in income securities may be affected by changes in the creditworthiness of the issuer and are subject to the risk of non–payment of principal and interest. The value of income securities also may decline because of real or perceived concerns about the issuer's ability to make principal and interest payments. Derivatives instruments can be used to take both long and short positions, be highly volatile, result in economic leverage (which can magnify losses), and involve risks in addition to the risks of the underlying instrument on which the derivative is based, such as counterparty, correlation and liquidity risk. If a counterparty is unable to honor its commitments, the value of Fund shares may decline and/or the Fund could experience delays in the return of collateral or other assets held by the counterparty. The value of commodities investments will generally be affected by overall market movements and factors specific to a particular industry or commodity, including weather, embargoes, tariffs, or health, political, international and regulatory developments. As interest rates rise, the value of certain income investments is likely to decline. Because the Fund investments may be concentrated in a particular geographic region or country, the Fund share value may fluctuate more than that of a less concentrated fund. Investments rated below investment grade (typically referred to as "junk") are generally subject to greater price volatility and illiquidity than higher rated investments. No Fund is a complete investment program and you may lose money investing in a Fund. The Fund may engage in other investment practices that may involve additional risks and you should review the Fund prospectus for a complete description.