Thomas Fetter, manager of Eaton Vance Municipal Bond Fund (ETMBX), doesn’t take all the credit for being chosen as a winner of a 2005 Standard & Poor’s/BusinessWeek Excellence in Fund Management Award. Fetter stresses the importance of his 36-member team as crucial to the fine performance of the portfolio. Indeed, consistently outperforming his peers over the one-, three-, and five-year periods is certainly music to his investors’ ears.
Fetter has led the portfolio through structural changes since he became manager in April 1986. Originally issued as a limited partnership in 1978, Class A and B shares became available in 1998. Since inception, the fund has maintained a non-AMT (alternative minimum tax) policy by holding mainly traditional municipal bonds, e.g. water, sewage, highway, power, or other essential purpose securities, which are fully federal income tax exempt. The AMT, which hits income from certain types of municipal bonds, is intended to prevent higher income taxpayers from excessively reducing their tax liability through the use of preferences in the tax code.
Fetter manages Eaton Vance Municipal Bond Fund by dividing it into several components including “income,” comprised of higher-yielding securities; “performance”, or very high-quality securities that make up the bulk of the portfolio, such as insured bonds that help generate performance; and “value,” or undervalued securities, which are considered based on criteria such as coupon structure, call protection, and overall portfolio diversification. While Fetter sets the objective and strategy of the fund and manages the allocation, traders and researchers suggest ideas for potential investments.
Fetter and his team aim to be opportunistic in a fairly conservative way by employing a consistent management style focused on value, which can be seen when he invests in specialty state paper priced on the national level. For example, if issuance for New Jersey state securities is roughly $20 million per week, an overissuance of $100 million will force underwriters to price that bond at the national level, or in other words, at lower prices than what New Jersey residents are willing to pay. Fetter takes advantage of undervalued bonds and holds them in the portfolio for about a year, selling when the demand for New Jersey state bonds is high again, but availability is low. That allows him to obtain a higher price and take advantage of the premium.
The fund takes a long-term approach, in line with the yield curve, which has traditionally been fairly steep over the long run. Fetter also maintains a fairly long call protection within the portfolio, which he says is the only facet a manager has complete control over in such a fund. Call protection, a provision setting a certain period during which a bond cannot be redeemed by the issuer, provides the ability to produce a steady predictable stream of tax-exempt income over a long period of time. The average call protection for the fund is about ten years. As bonds within the portfolio approach their first call date, Fetter trims those bonds, trading them out for ones with longer call protection, thereby protecting the future dividend stream.
Currently, Fetter is overweight in general obligation (issued by state and local governments) and health care bonds. He also favors special revenue bonds because of their specific flow of revenue from the issuer that supports growth. Avoiding premium bonds, he tends to buy discount bonds like zero-coupons bonds because of their duration and reinvestment characteristics. As of March 31, nearly 49.0% of the holdings were AAA-rated, and 72.6% were investment grade. Non-rated bonds comprised 24.8% of the portfolio. Internal credit analysts evaluate each non-rated issue and assign a numerical rating based on a scale developed over time within the organization. The internal rating then dictates what the analyst perceives the credit risk to be and the maximum percentage that can be held within the fund.
Average duration for the fund as of the end of March was 6.2 years, and the average coupon was 5.5%. Fetter feels it’s more important to look at the funds distribution rate and not the average yield, the former is a more accurate measure of what clients receive. The current A share class distribution rate is 4.73%. The average weighted maturity of the portfolio is 22 years, and the average bond rating is A+. Adding to the list of positive portfolio characteristics is the fund’s low 36% turnover rate for 2004, well below its peers.
Outstanding municipal debt obligations totaled $2.03 trillion at the end of December 31, 2004* and according to April 2004 figures from the Investment Company Institute (ICI), $328 billion are held in municipal bond funds. Fetter notes that even though issuance varies occasionally, municipal issuance is continuing to grow modestly due to inflation and strong demand on state and local governments for essential services. Both larger and smaller investors are typical shareholders for the $136 billion fund, including Fetter, a significant investor in his own fund.
Eaton Vance Municipal Bond Fund has outperformed both its peers and the Lehman Brothers Municipal Bond Index, a widely used benchmark, in all periods reviewed. As of April 29, 2005, the fund’s A Class shares gained 7.3%, 6.9% and 8.0% for the one-, three-, and five-year periods, respectively, while its peers rose, 6.1%, 5.5%, and 6.4% over the same periods. The Lehman Brothers Municipal Bond Index earned 6.8%, 6.0%, and 7.0% for the one-, three-, and five-year periods. Based on five-year total returns, the fund ranked 19 within the entire universe of 1,614 funds in the domestic tax-exempt fixed-income category, and fourth out of 118 peer national long-term municipal bond funds.
*The Federal Reserve Board’s Flow of Funds Accounts of the United States
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