Government Obligations Fund (A) Share
Class

A

• A
• B
• C
• I
• R

A Word On The Markets  as of Mar 31, 2013

The first quarter began with the U.S. economy facing a number of headwinds. After Congress weathered the “fiscal cliff” storm at the beginning of the quarter, investor fears that the U.S. economy would face the full force of significantly higher taxes subsided. As U.S. economic data strengthened, investors became more comfortable and a rally in riskier assets, such as high-yield bonds, ensued. As the U.S. economy gained steam, the dysfunction in Washington resumed on March 1 with the automatic spending cuts, known as sequestration, triggered by an impasse between Democrats and Republicans. The U.S. labor market has yet to see the full potential impact of the sequestration cuts, which have the potential to meaningfully impact the U.S. economy in the months to come.

Despite renewed optimism in the U.S. economy, job growth actually slowed in the first quarter, with the three-month average through March coming in at 168,000 per month after recent revisions, well below the 209,000 per month averaged in the fourth quarter of 2012. As the labor market continued to add jobs, several Federal Reserve (the Fed) officials spoke about when and how the current mortgage-backed securities (MBS) and Treasury quantitative easing (QE) programs should be wound down. As it stands now, both QE programs are still ongoing to the tune of $85 billion in purchases per month, with no imminent end in sight.

Even with mortgage rates hovering around all-time lows during most of the quarter, changes in generic and seasoned agency MBS prepayments remained relatively muted. Many of the largest lenders continued to deal with capacity constraints during the quarter, which helped keep prepayment speeds depressed. Despite the Fed’s heavy involvement in both the Treasury and agency MBS markets, yields finished the quarter higher in both markets. Seasoned and generic agency MBS spreads ended the quarter wider to Treasurys, partially due to fears the Fed would begin lessening its mortgage purchases.

Performance Summary 

Eaton Vance Government Obligations Fund (the Fund) underperformed its benchmark, the Barclays Capital U.S. Intermediate Government Index (the Index),² during the quarter.

• The Fund benefited from its focus on seasoned MBS, which continued to prepay at more stable rates than generic MBS.
• A steepening in the U.S. Treasury yield curve led to underperformance of the Fund’s longer-duration⁹ assets.

Contributors 

Factors contributing to the Fund’s relative performance compared to the Index during the quarter:

• The Fund benefited from its focus on seasoned MBS, which had more stable prepayment rates than most generic MBS during the quarter.

Detractors 

Factors detracting from the Fund’s relative performance compared to the Index during the quarter:

• Mortgage spreads relative to Treasurys widened during the quarter, which hurt performance.
• A steepening of the yield curve led to an underperformance of bonds with durations longer than those of the Index.

Investment Outlook And Fund Positioning 

Management believes that although Congress removed some uncertainty from the market when it agreed to a deal on the tax side of the equation, headwinds still remain for the U.S. economy with the looming sequestration cuts. Although economic growth in the U.S. is expected to increase in the first quarter, the economy only grew 0.4% in the fourth quarter, far from levels deemed acceptable by the Fed. The fiscal drag in the coming year, coupled with another potential fight over the debt ceiling this summer could depress consumer and business sentiment and dampen any continued recovery in the U.S. economy. We believe the fragile state of the U.S. economy will keep the Fed committed to its loose monetary policy for the foreseeable future, which should be supportive of both the U.S. Treasury and agency MBS markets.

We believe the MBS market continues to hold value relative to most other U.S. government securities. Supply/demand technicals remain supportive of agency MBS spreads, as the Fed will continue its purchases of over $40 billion in new bonds on a net basis per month and now owns over 20% of outstanding agency MBS. As mortgage rates continue to hover around all-time lows, prepayment rates on seasoned agency MBS—like those owned by the Fund—continue to prepay at stable rates. We believe that seasoned agency MBS offer the most potential value in the agency MBS market and don’t have the same level of extension risk that generic MBS have.

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.

Portfolio profile subject to change due to active management. Percentages may not total 100% due to rounding. 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.

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. As interest rates rise, the value of certain income investments is likely to decline. 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. While certain U.S. government-sponsored agencies may be chartered or sponsored by acts of Congress, their securities are neither issued nor guaranteed by the U.S. Treasury. 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. 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.

Portfolio profile subject to change due to active management. Percentages may not total 100% due to rounding. 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.

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. As interest rates rise, the value of certain income investments is likely to decline. 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. While certain U.S. government-sponsored agencies may be chartered or sponsored by acts of Congress, their securities are neither issued nor guaranteed by the U.S. Treasury. 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. 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.