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This Bank-Loan Fund Is a Standout

A sound, repeatable process executed by an experienced team drove us to upgrade our rating on this closed-end fund. 

Sumit Desai, CFA, 04/11/2014

Few asset classes have received as much attention lately as bank loans (also known as senior loans or floating-rate loans). In the past 12 months, $54 billion has flown into the open-end bank-loan category as income-seeking investors look for protection against a potential rise in interest rates. As we've discussed before, senior loans pay interest to investors based on a floating rate that is generally reset quarterly. That rate is based on a reference index or rate (usually Libor) plus a spread, which is generally determined based on the credit risk of the portfolio's underlying assets. So, in a rising-rate environment, floating-rate loans should pay investors more income. 

These investments are not without risks, though. Many bank loans were recently issued with Libor floors that rates must exceed before higher coupon payments start kicking in. As a result, rates may need to increase dramatically before investors see any benefits from owning certain loans. Also, floating-rate loans still carry significant credit risk. Corporate fundamentals remain strong and default rates are low, but any signs of weakening economic activity could hurt this category. It's feasible that the fast money that poured into bank-loan funds may just as quickly pull out at the earliest signs of distress. Flows don't have a direct impact on closed-end funds on a net asset value basis, but sharp outflows from open-end funds could still have an impact on CEF performance. In addition, negative investor sentiment could widen discounts across the sector, hurting share price performance.

Among closed-end bank-loan funds, Eaton Vance Floating Rate Income's EFTfundamentally sound, repeatable process makes it a standout. Because of this, we recently upgraded the fund's Morningstar Analyst Rating to Silver from Bronze. The fund's restrained approach may not consistently land it in the top tiers of the bank-loan category, or even atop its benchmark, the S&P/LSTA Leveraged Loan Index, but over time it has kept up with its peer group while keeping volatility in check. The fund returned 5.2% for the year ended April 6, 2014, compared with 7.4% for the category average, placing it behind 85% of its peers. A key driver of this underperformance was the fund's general avoidance of CCC loans, which performed significantly better than higher-quality loans in 2013. Over the past five years, though, the fund’s 19.2% annualized return is right in line with the category average.

For investors who are interested in Eaton Vance Floating Rate Income, shares appear reasonably valued: The fund currently trades at a 4.7% discount, which is near its six-month average but much lower than its three-year average premium of 0.67%. Over the past three years, the fund has traded between a premium of 10.4% and a discount of 9.7%.

People
Scott Page, who has managed this fund since its inception in 2004, is a longtime veteran of the bank-loan asset class. He joined Eaton Vance as a bank-loan analyst in 1989. Craig Russ, director of credit analysis, oversees all credit research for the floating-rate group. He joined Page in 2007. Ralph Hinckley joined this fund's team in 2008 and was previously a credit analyst for the firm.

Managers are supported by a 13-person analyst team, which includes eight veteran analysts, each of whom has more than a decade of experience. Other resources supporting the group include a formal two-person team dedicated to handling workouts and an additional trader.

The team earns high marks on several funds it manages, including open-end Eaton Vance Floating Rate EVBLX and Eaton Vance Floating-Rate AdvantageEIFAX, which also earn Gold and Silver Analyst Ratings, respectively.

Process
The fund must hold at least 80% of its assets in bank loans but generally holds closer to 90%. The remaining allocation is flexible, but typically, its managers hold high-yield bonds and some asset-backed securities.

Sumit Desai, CFA is a senior stock analyst with Morningstar.
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