What are municipal floating-rate securities? How do they differ from typical municipal securities?
Municipal floating-rate notes, or FRNS, municipal securities for which the coupon rate floats, or resets, at periodic intervals. Other than that, FRNs are regular municipal securities issued by the same issuers as typical fixed-coupon municipal bonds. In general, the floating-rate indexes reset weekly, while floating-rate bonds pay out their coupon monthly or quarterly. FRNs do not all reset on the same schedule, so in any given week there will likely be some bonds in the Fund whose rates are resetting. As a municipal bond fund, this portfolio also offers investors the same exemption from federal income taxes provided by most tax-exempt1 municipal bond products.
What makes this asset class potentially attractive to investors?
There is potential for additional income coupled with relative price stability, if and when the Federal Reserve (the Fed) raises the fed funds rate—i.e., short-term interest rates. Whereas short-maturity fixed-rate bonds will likely decline in price when the Fed starts raising short-term rates, FRNs may experience relatively stable prices coupled with the potential benefit of higher income as the securities reset to a higher interest rate and higher coupon. So investors in short-maturity FRNs could benefit if and when the Fed raises short-term rates.
How do FRNs compare with corporate floating-rate loans, another low-duration asset class that investors may be familiar with?
The asset classes are similar in that both generally provide rising income payments as interest rates rise. FRNs, however, are mostly investment-grade securities, while floating-rate loans are typically below investment grade. As a result, FRNs may offer lower credit risk but also lower interest payments, compared with floating-rate loans. In addition, income from FRNs is exempt from federal taxes, while income from loans is federally taxable.
Who should consider investing in Floating-Rate Municipal Income Fund and why?
I believe that investors will consider this fund for three main reasons. First, they may want to garner some benefit when the Fed begins to raise short-term interest rates. Second, they may be looking for an alternative or complement to short-term municipal bond funds—because even with short-term bonds, in a rising rate environment investors are locked in to an interest rate for one to five years, depending on the maturity structure of their particular short-term portfolio. And third, they may want to shorten their overall portfolio duration by adding a holding with a very short duration—about one year in the case of this fund.
We’re often asked how this fund should be used within a portfolio. Of course, that varies somewhat with each investor. But with the Fed telling us that the fed funds rate will, at some point, go up if certain economic criteria are met, this fund could be a core position within an investor’s fixed-income allocation. We think using this fund for a portion of a portfolio’s tax-exempt fixed-income allocation could be a reasonable starting point.
I would also point out that this is the first and, so far, the only floating-rate municipal income mutual fund, so it is currently the only mutual fund designed to focus on this portion of the market.
What risks should investors be aware of in this Fund?
This is not a money market mutual fund or stable NAV fund. The NAV can and likely will move during significant market fluctuations. FRNs are issued with maturities ranging from one year to 30 years, just like fixed-coupon muni bonds. Also, just like traditional fixed-rate municipal bonds, 30-year-maturity FRNs are more sensitive to movements in long-term municipal interest rates than one-year FRNs. However, my goal as manager of this fund is to minimize this volatility by investing in shorter-maturity floating-rate bonds. As a result, the Fund’s volatility should be lower than traditional municipal bond funds.
Why would investors buy a long-maturity floating-rate note?
Just like any other bond, investors get paid a higher interest rate for assuming the risk of a longer-maturity bond, or a lower-credit-quality bond, for that matter.
For example, a theoretical three-year AAA-rated FRN might pay the weekly rate plus 0.20%, while a 30-year FRN could pay the weekly rate plus 1.20%. A theoretical three-year BBB-rated FRN could pay the weekly rate plus 0.75%. We intend to focus on investing in shorter-maturity, high-quality FRNs to limit the potential volatility associated with a longer-maturity FRN and to rely on our extensive research staff to add incremental value by investing in some lower-rated investment-grade credits.
What is your strategy in managing the Fund?
Our goal is to seek tax-exempt income while providing a potential hedge against rising municipal rates. Our strategy in pursuing that goal has several elements. Although the prospectus allows the Fund to own longer-term bonds, our strategy in the current rising-rate environment is to buy shorter-maturity FRNs with shorter mandatory puts and optional calls to help mitigate volatility.
In order to get the desired income from shorter maturity issues, another part of our strategy is to invest in medium to lower-quality, investment-grade bonds, for the incremental income they offer. I think the key to doing this successfully is utilizing the credit research expertise here at Eaton Vance. With 14 dedicated municipal analysts, we have one of the most experienced teams and one of the largest analysts-to-assets-under-management ratios in the U.S. Since FRNs are generally issued by traditional municipal issuers, our analysts are often already familiar with many of these issuers.
What are synthetic floating-rate securities and how do you intend to use them in the Fund?
A question we’re often asked is whether synthetic floating-rate bonds are part of our strategy. We would consider using some synthetic floating-rate bonds to enhance the portfolio’s income. A synthetic floating-rate security is simply the combination of a traditional fixed-rate municipal bond that has been “turned into” a floating-rate bond by purchasing an interest-rate swap, which is an agreement to swap fixed-rate payments for a floating-rate payment. I consider synthetic securities to be another tool in the toolkit that we can use to seek incremental income while continuing to manage the volatility of the Fund.
What would you say to investors who argue it is too early to seek protection from rising interest rates?
If you’re an investor looking to put money to work today in a short-duration investment, we would say this Fund deserves your consideration. Take a look at your alternatives. Money markets are currently paying essentially zero and short-term bonds will likely lose value once rates start to move up without the benefit of a higher income stream as short-term rates rise.
In the near term, before the Fed signals it’s about to raise rates, we believe the investment experience with the Fund will be similar to a short-term municipal bond fund. In the current environment, our goal is to manage the Fund to minimize—although not eliminate—volatility and deliver income comparable to that of a short-term investment-grade municipal fund.
When the Fed does pull up the anchor and short-term rates begin to rise, our primary goal is to provide rising income payments with relative price stability. What we’re striving to do is deliver an investment experience where the return comes almost entirely from income, which goes up when either the weekly SIFMA Index2 or short-term Libor increase.
1A portion of municipal income may be subject to federal, state and/or local income taxes, and may also be subject to federal alternative minimum tax.
2The SIFMA Municipal Swap Index, produced by Municipal Market Data (MMD), is a seven-day high-grade market index comprised of tax-exempt variable rate demand obligations (VRDOs) from MMD’s extensive database. It is not possible to invest directly in an index.
Prior to 8/19/13, Fund was called Eaton Vance AMT-Free Limited Maturity Municipal Income Fund.
This Q&A includes comparisons of different asset classes, each of which has distinct risk and return characteristics. Every investment carries risk, and principal values and performance will fluctuate with all asset classes shown, sometimes substantially. All asset classes are subject to risks, including possible loss of principal invested. The principal risks involved with investing in the asset classes discussed are interest-rate risk, credit risk and liquidity risk, with each asset class shown offering a distinct combination of these risks. Costs and expenses associated with investing in asset classes will vary, sometimes substantially, depending upon specific investment vehicles chosen. Interest income earned on asset classes shown is subject to ordinary federal, state and local income taxes, except municipal securities (exempt from federal income taxes, with certain securities exempt from federal, state and local income taxes). In addition, federal and/or state capital gains taxes may apply to investments that are sold at a profit. Eaton Vance does not provide tax or legal advice. Prospective investors should consult with a tax or legal advisor before making any investment decision.
Ratings are based on Moody’s, S&P or Fitch, as applicable. Ratings, which are subject to change, apply to the creditworthiness of the issuers of the underlying securities and not to the Fund or its shares. Credit ratings measure the quality of a bond based on the issuer’s creditworthiness, with ratings ranging from AAA, being the highest, to D, being the lowest based on S&P’s measures. Ratings of BBB or higher by S&P or Fitch (Baa or higher by Moody’s) are considered to be investment grade quality. Credit ratings are based largely on the rating agency’s analysis at the time of rating. The rating assigned to any particular security is not necessarily a reflection of the issuer’s current financial condition and does not necessarily reflect its assessment of the volatility of a security’s market value or of the liquidity of an investment in the security. If securities are rated differently by the rating agencies, the higher rating is applied.
The views expressed in this discussion are those of Craig Brandon 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 for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. This discussion may contain statements that are not historical facts, referred to as forward-looking statements. Future results may differ significantly from those stated in forward-looking statements, depending on factors such as changes in securities or financial markets or general economic conditions.
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 interestrate 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 nonpayment 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.
About Eaton Vance
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