National Municipal Income Fund (A)

A Word On The Markets  as of Mar 31, 2012

The municipal bond market, as measured by the Barclays Capital Municipal Bond Index², gained 1.75% in the first quarter of 2012. The bulk of that advance came in the first six weeks of the period when an extended January effect bolstered the market. Low new bond issuance was met with robust demand, as investors appeared to reinvest both coupons and the proceeds from munis maturing at the end of 2011.

From about mid-February through the end of the quarter, muni returns were muted. Muni yields rose, mirroring similar action in the Treasury market after the Federal Reserve slightly upgraded its view of the economy and Greece's debt restructuring came to an orderly conclusion. These developments, among others, seemed to encourage investors to take on more risk and seek higher-yielding investments outside munis. Demand was further curtailed in March, a historically weaker period for munis, as investors pulled money out of the market ahead of the April tax deadline. An increase in supply also acted as a drag, as new issuance rebounded from relatively anemic levels in March 2011 and refunding (the issuance of new bonds for the purpose of retiring outstanding bond issues) boomed as issuers took advantage of historically low yields to cut their debt costs.

The yield curve, a graphical representation of the yields offered by bonds of various maturities, flattened during the quarter. As such, longer-term bonds slightly outpaced shorter-maturity securities as investors moved out the yield curve - particularly during the January effect to capture higher yields. On a total return basis, lower-quality bonds also benefited from demand from yield-hungry investors and outpaced higher-quality bonds as a result.

Performance Summary 

Eaton Vance National Municipal Income Fund significantly outperformed its benchmark, the Barclays Capital Municipal Bond Index, at net asset value, during the quarter.

• The Fund's holdings in U.S. Treasury futures - used to manage its yield curve positioning - were key contributors to outperformance.
• Overweighting longer-maturity and longer-duration bonds proved advantageous, as they outpaced shorter-maturity and shorter-duration securities.
• The Fund's overweighting to zero coupon bonds and bonds with coupons of 9+ was helpful, as was security selection in these two areas. Larger-than-benchmark exposure to IDR/PCR (industrial development revenue/pollution control revenue) bonds proved advantageous, as they outpaced the market.
• Security selection overall was positive, with good picks among lower-rated investment-grade bonds, special tax bonds and California bonds each bolstering the Fund's relative performance.
• Considering the Fund's large margin of outperformance of its benchmark, there were no significant detractors from performance during the quarter.

Contributors 

The Fund's out-of-benchmark position in Treasury futures contributed to outperformance. These securities outpaced the benchmark, as Treasury yields drifted higher during the quarter.

• An overweighting in bonds with maturities of 20+ years proved advantageous, as they significantly outperformed shorter-term bonds. Similarly, overweighting bonds with durations of longer than 20 years or longer also helped, as they outpaced the benchmark.
• An overweighting in zero coupon bonds and those with coupons above 9% helped, as did good picks for both segments.
• Elsewhere, the Fund's overweighting in IDR/PCR (industrial development revenue/pollution control revenue) bonds, which outpaced the Index, also contributed. Advantageous credit quality positioning was another plus. The Fund's overweighting in bonds rated A/A and BBB/Baa bolstered its performance, as lower-quality investment-grade securities outpaced higher-quality bonds, in which the Fund was underweighted.
• Security selection overall was a plus, particularly good picks among A/A-rated bonds, BBB/Baa-rated bonds, special tax bonds and California munis.

Detractors 

There were no material detractors from the Fund's relative performance versus the benchmark during the quarter.

Investment Outlook And Fund Positioning 

Our outlook for the muni bond market is cautiously optimistic. Credit trends appear to be stabilizing. State and local governments seemed to have gained traction against their structural problems, shedding jobs and enjoying the benefits of rising revenues. Although much more sustained progress on pension reform is needed to address the massive future obligations for pensions and other unfunded liabilities, we believe the municipal market is fundamentally sound. From a technical perspective, we think demand may continue to remain firm, as top earners take steps now to blunt some of the effects of the expected end of the Bush-era tax cuts and the imposition of new taxes, which together will result in sizable tax hikes in 2013. Furthermore, demand likely will be bolstered by reinvestment activity, which tends to be particularly strong during mid-year, as issuers pay coupons, call bonds and pay off maturing bonds along with other factors. Although new issue supply in 2012 may exceed the level of 2011, we do not believe the new issue supply will keep pace with bond redemptions, resulting in net negative supply this year.

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.

About Risk 

An imbalance in supply and demand in the municipal market may result in valuation uncertainties and greater volatility, less liquidity, widening credit spreads and a lack of price transparency in the market. There generally is limited public information about municipal issuers. As interest rates rise, the value of certain income investments is likely to decline. Longer-term bonds typically are more sensitive to interest-rate changes than shorter-term bonds. 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. 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.

About Risk 

An imbalance in supply and demand in the municipal market may result in valuation uncertainties and greater volatility, less liquidity, widening credit spreads and a lack of price transparency in the market. There generally is limited public information about municipal issuers. As interest rates rise, the value of certain income investments is likely to decline. Longer-term bonds typically are more sensitive to interest-rate changes than shorter-term bonds. 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. 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.