Floating-Rate Fund (A)

A Word On The Markets  as of Dec 31, 2011

After a difficult third quarter, the S&P/LSTA Leveraged Loan Index³, the broad barometer for the U.S. floating-rate loan market, rebounded in the final quarter of the year, posting a return of +2.91% for the three-month period ended December 31, 2011. Performance reflected a modest increase in loan prices, plus investment income. Macroeconomic forces and technical trends provided a generally supportive backdrop for risk markets during the period. Efforts by European leaders to stem that region's debt crisis, better-than-expected U.S. economic data, good quarterly corporate earnings results and optimistic guidance, and a sharp drop in market volatility were roundly welcomed by investors. Despite these positives, net flows into loan mutual funds remained negative in the quarter. However, overall loan demand still outpaced supply, driven by a combination of low new-issue volume, an uptick in collateralized loan obligation issuance and nontraditional account buying, and the fact that many fund managers had raised meaningful cash during the record outflows of August and September.

Loan market returns for the quarter occurred early. In October, the S&P/LSTA Leveraged Loan Index recorded its best monthly return since 2009 (+2.89%), though it was followed by a modest sell-off in November (-0.49%) amid renewed European worries and market participants' dampened appetite for risk. The market quickly retraced in December (+0.51%), however, when moderating outflows combined with limited new issue supply. The year finished with the loan market on solid technical footing, with investor demand for risk again rejuvenated, thanks to new hopes that European leaders were on a path toward resolution of their fiscal problems, as well as further encouraging data for the U.S. economy.

Despite the somewhat uncertain economic backdrop, issuer fundamentals remained solid throughout the quarter. By December 31, 2011, the trailing 12-month default rate by principal amount in the loan market declined to a 54-month low, closing the period close to zero percent.

Performance Summary 

Floating Rate Fund underperformed its benchmark, the S&P/LSTA Leveraged Loan Index, during the fourth quarter at net asset value. Relative performance compared to the benchmark for the period was primarily driven by the Fund's higher-credit-quality positioning and broad level of diversification¹².

• The Fund's general bias toward the higher quality end of the loan market detracted from relative performance, as lower quality B rated loans outperformed higher-rated BB loans¹³.
• The benchmark's larger cap, more liquid names, which experienced greater selling pressure during the prior quarter, outperformed the broad market. As a result, the Fund's broad diversification beyond these more liquid issues weighed on relative returns.
• The Fund generated attractive income during the quarter, even with LIBOR near all time lows.

Contributors 

Factors contributing to the Fund's relative performance compared to the benchmark during the quarter:

• While higher-quality loans underperformed lower-quality loans for the vast majority of the loan market rated BB and B, CCC-rated loans in the benchmark performed notably lower than both, posting a quarterly return of 0.68%. The Fund's considerable underweight to CCC-rated loans¹³ was additive to relative returns.
• Underweight positioning in the publishing and utilities sectors aided relative returns, as these segments underperformed the broad loan market, while an overweight to the automotive sector aided relative performance, as this sector outperformed the overall loan market.

Detractors 

Factors detracting from the Fund's relative performance compared to the benchmark during the quarter:

• In the BB/B segment of the market, the Fund's continued bias against lower quality loans detracted from relative performance as higher quality loans underperformed. BB rated and B rated loans in the benchmark returned 3.09% and 3.44%, respectively. The Fund was underweight the B rated segment of the market and overweight BB rated loans, positioning which detracted from relative performance.
• The Fund's broad diversification beyond the more liquid names in the benchmark weighed on relative returns, as the 100 largest names in the benchmark collectively returned 3.67% for the quarter.

Investment Outlook And Fund Positioning 

We believe new issuance in early 2012 is likely to remain light, given the significant level of refinancing during the past three years and a generally quiet M&A calendar. On the demand side, visible repayments also appear light, and we think collateralized-loan-obligation demand will be limited. All of this points to retail loan fund investors as the critical variable in setting the direction of the market's supply/demand balance. We think the market may remain sensitive to fund flows activity and to macro factors. In the short term, we think investors likely will remain reactive to macroeconomic conditions. We expect consumers and businesses to remain restrained, resulting in subpar global economic output. Even so, we think floating-rate loans appear attractive in 2012, considering their wide spreads and that we anticipate default rates will remain well below long-term averages.

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 invests in an affiliated investment company (Portfolio) with the same objective(s) and policies as the Fund. 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 

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. There can be no assurance that the liquidation of collateral securing an investment will satisfy the issuer's obligation in the event of nonpayment or that collateral can be readily liquidated. The ability to realize the benefits of any collateral may be delayed or limited. 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. Investments rated below investment grade (typically referred to as "junk") are generally subject to greater price volatility and illiquidity than higher rated investments. As interest rates rise, the value of certain income investments is likely to decline. Bank loans are subject to prepayment 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. Changes in the value of investments entered for hedging purposes may not match those of the position being hedged. 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 invests in an affiliated investment company (Portfolio) with the same objective(s) and policies as the Fund. 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 

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. There can be no assurance that the liquidation of collateral securing an investment will satisfy the issuer's obligation in the event of nonpayment or that collateral can be readily liquidated. The ability to realize the benefits of any collateral may be delayed or limited. 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. Investments rated below investment grade (typically referred to as "junk") are generally subject to greater price volatility and illiquidity than higher rated investments. As interest rates rise, the value of certain income investments is likely to decline. Bank loans are subject to prepayment 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. Changes in the value of investments entered for hedging purposes may not match those of the position being hedged. 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.