Short Term Real Return Fund (A)

A Word On The Markets  as of Mar 31, 2012

In the first quarter of 2012, constructive developments in Europe eased fears that the region's sovereign debt crisis might destabilize the global financial system. The European Central Bank (ECB) implemented its second round of the Long-Term Refinancing Operation (LTRO), a special lending facility that provides banks with low-interest term financing. Additionally, Greece reached a deal with private bondholders to restructure its debt.

As concerns about systemic risk in Europe faded, investors focused on signs of improvement in the U.S. economy. The unemployment rate fell to 8.3%, and initial jobless claims sank to their lowest level since April 2008. Manufacturing activity continued to expand, durable goods orders trended higher and a key index of leading indicators rose for a fifth straight month. The Federal Reserve acknowledged the improvement in the economy. Nonetheless, the Fed pledged to keep interest rates exceptionally low through late 2014, extending its previous mid-2013 timeframe.

In the risk-on environment, equities rallied and credit spreads narrowed. However, real U.S. interest rates (those net of inflation expectations) did not rise the way they typically do when investors become more optimistic about the economy. Many market participants attributed this phenomenon to Operation Twist, a stimulus program in which the Fed is buying longer-term Treasuries with the proceeds of maturing shorter-term Treasuries. While real rates were flat to down, nominal rates increased, reflecting rising inflation expectations.

Performance Summary 

During the first quarter, Eaton Vance Short Term Real Return Fund outperformed its benchmark, the BofA Merrill Lynch 1-5 Year U.S. Inflation-Linked Treasury Index², at net asset value.

• The Fund's performance was driven by its allocation to floating-rate loans. The floating-rate loan market generated a solid gain during the quarter, as risk appetites rose and investors gravitated toward credit-sensitive instruments.
• Treasury Inflation-Protected Securities (TIPS) market generally rose in price as demand for inflation protection increased in response to the encouraging U.S. economic data, higher oil prices and the Fed's commitment to keeping short-term rates near zero through 2014.

Contributors 

Factors positively impacting Fund performance relative to the benchmark during the quarter:

• TIPS generated healthy gains but did not keep pace with the floating-rate loan market. Consequently, the Fund's investments in floating-rate loans aided results versus the TIPS-based Index.
• The Fund's strategy to swap LIBOR-based payments on its floating-rate loans for payments based on changes in the U.S. Consumer Price Index (CPI) made a small positive contribution to return, as LIBOR remained low while CPI increased during the quarter.

Detractors 

Factors negatively impacting Fund performance relative to the benchmark during the quarter:

• The Fund has a shorter average duration than the benchmark, so it is less sensitive to changes in interest rates. This was a headwind to relative performance this period given the decrease in real yields across most maturities.

Investment Outlook And Fund Positioning 

We believe the chances for higher inflation are rising. The Fed is clearly committed to easy monetary policy and has adopted a more dovish tone this year. Moreover, the Fed has been actively discussing allowing inflation to move higher, at least temporarily, in the hopes of spurring economic growth. The ECB and other foreign central banks have also been pumping liquidity into the financial system, contributing to the risk of higher inflation.

At quarter-end, the Fund had a 60% allocation to short and intermediate TIPS and a 34% allocation to floating-rate loans (whose LIBOR-based interest rate payments are swapped for payments based on changes in the CPI, as previously noted). We believe this makes the Fund well positioned to provide protection against rising inflation.

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 one or more affiliated investment companies (Portfolios) and may also invest directly. Unless otherwise noted, references to investments are to the aggregate holdings of the Fund and the Portfolios. 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. Interest payments on inflation-linked securities may vary widely and will fluctuate as principal and interest are adjusted for inflation. Investments in inflation-linked securities may lose value in the event that the actual rate of inflation is different than the rate of the inflation index. 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. 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. 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.

Fund primarily invests in one or more affiliated investment companies (Portfolios) and may also invest directly. Unless otherwise noted, references to investments are to the aggregate holdings of the Fund and the Portfolios. 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. Interest payments on inflation-linked securities may vary widely and will fluctuate as principal and interest are adjusted for inflation. Investments in inflation-linked securities may lose value in the event that the actual rate of inflation is different than the rate of the inflation index. 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. 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. 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.