Short Term Real Return Fund (A) Share
Class

A

• A
• C
• I

A Word On The Markets  as of Mar 31, 2013

The economic recovery continued in the first quarter of 2013, with U.S. gross domestic product (GDP) growth expected to be 2% to 3% after dipping near zero in the previous quarter. While the recovery remains uneven, barriers to confidence resulting from uncertainty appear to be coming down: elections are over, Congress has reached a fiscal cliff agreement and the sequester that took effect on March 1 caused only modest disruption. Meanwhile, rising home and equity values are improving consumer confidence and balance sheets.

The Federal Reserve Board’s (the Fed) most recent minutes repeated its intent to continue with quantitative easing (QE), buying about $85 billion per month in Treasurys and mortgage-backed securities. The Fed made it clear that, while it saw moderate growth continuing, the majority of its committee members did not see unemployment reaching their goal of 6.5% before 2015—and therefore they did not expect to end QE before then.

In our view, the Fed’s emphasis on employment rather than inflation represents a growing risk. Inflationary pressures have remained modest, despite the $1.6 trillion in excess reserves currently on deposit at the Fed, because the reserves were not entering the economy via bank lending. However, recent growth in the volume of commercial and industrial loans suggests that this dynamic may be changing and may well set the stage for a significant surge in monetary velocity. This is occurring against the backdrop of an economy ending its fourth year of recovery—typically the point in the business cycle when inflationary pressures begin to manifest themselves.

Performance Summary 

Eaton Vance Short Term Real Return Fund (the Fund) outperformed its benchmark, the BofA Merrill Lynch 1–5 Year U.S. Inflation-Linked Treasury Index (the Index),² at net asset value during the quarter.

• Treasury Inflation-Protected Securities (TIPS) in the Index accrued a -0.45% Consumer Price Index (CPI) inflation return along with a negative real yield for the period. Nonetheless, declining real rates pushed the prices of TIPS higher and produced a positive return for the Index.
• Bank loans, which are not held by the Index, outperformed TIPS and U.S. Treasurys during the quarter. Although the Fund’s TIPs allocation underperformed the Index, strong performance by the Fund’s bank loans led the Fund to outperform its benchmark.

Contributors 

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

• Bank loans, which are not held by the Index, outperformed U.S. Treasurys, as loan spreads tightened and their prices rose. Loans were the largest driver of relative returns.
• The Fund’s TIPS allocation produced higher yields than the Index.

Detractors 

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

• Over the quarter, due to the seasonal nature of inflation, investors favored TIPS with January and July maturity dates, while the Fund emphasized TIPS with April maturity dates due to their higher yield. Higher yield, however, was not sufficient to offset the additional price appreciation that benefited the later maturities, so the Fund’s overweighting in TIPS with April maturities detracted from relative results.
• The Fund’s strategy of swapping Libor-based interest-rate payments on its floating-rate loans for payments based on changes in the U.S. CPI detracted from performance.

Investment Outlook And Fund Positioning 

Late in the quarter, the Fund reduced its allocation to bank loans and TIPS by about 10% each and added a 20% allocation to short duration, very high quality commercial mortgage-backed securities (CMBS). The change in allocation increased the average credit quality of the underlying investments of the fund while reducing its volatility, and had negligible impact on its distribution rate. At quarter-end, the Fund had a 49% allocation to TIPS, a 19% allocation to CMBS and a 26% allocation to bank loans and 6% in cash reserves. Interest-rate payments on both the bank loans and CMBS were 100% swapped for payments based on changes in the CPI.

Given the amount of fiscal and monetary stimulus around the globe, we continued to position the Fund at quarter-end to help protect against increasing inflation and rising interest rates.

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 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.

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. Commercial mortgage-backed securities ("CMBS") are subject to credit, interest rate, prepayment and extension risks. 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. A non-diversified fund may be subject to greater risk by investing in a smaller number of investments than a diversified fund. 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 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.

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. Commercial mortgage-backed securities ("CMBS") are subject to credit, interest rate, prepayment and extension risks. 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. A non-diversified fund may be subject to greater risk by investing in a smaller number of investments than a diversified fund. 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.