Eaton Vance picks right time to buy bonds

By Sree Vidya Bhaktavatsalam - Bloomberg News 

Thomas Metzold, manager of the Eaton Vance National Municipals Fund, outperformed all of his peers and most stock funds over the past five years by purchasing bonds other investors avoided.

"We were willing to hold deep-discount bonds that nobody wanted," including those backed by payments from bankrupt airlines and tobacco companies that faced billions of dollars in legal costs, Metzold said in an interview from his office in Boston. "We picked the perfect time to buy."

The $4.3 billion fund, managed by Eaton Vance Corp., gained 11 percent in the past 12 months (through Oct. 31), double the average of its competitors. It advanced at an 8.3 percent annual rate since 2001, ranking first of 261 competing funds tracked by Chicago-based Morningstar.

The Standard & Poor's 500 index rose 7.3 percent a year in the same period.

Municipal bonds climbed this year after the Federal Reserve ended its two-year campaign of raising interest rates. Muni funds that invest in long-term securities increased 4.1 percent in 2006, the most in four years, Morningstar reported.

The Eaton Vance fund has about 12 percent of its assets in bonds that don't have credit ratings and typically pay higher interest than the average 3.8 percent on top-rated 10-year municipal general obligation bonds, according to data compiled by Bloomberg.

The next-best muni fund managed by a different fund family, the $481 million Pioneer AMT-Free Municipal Bond Fund, has 1.3 percent of its assets in unrated debt, and rose at a 5.7 percent annual pace in the past five years. Pioneer AMT is run by Boston-based Pioneer Investment Management.

Investors typically choose municipal bond funds because they are shielded from federal taxes. People in the 31 percent tax bracket earned about 11 percent a year from the Eaton Vance fund since 2001.

Metzold has 5.5 percent of the fund in airline bonds. He started buying the securities when prices fell after the Sept. 11 attacks. Another 2 percent is in bonds backed by some of the $206 billion that tobacco companies agreed to pay as part of a 1998 settlement.

Among his most lucrative bets were United Airlines bonds issued for Denver International Airport in 1992. Metzold bought the securities when they were trading at 90 cents on the dollar. He added more when they plunged to 68 cents in 2003 after United sought to get them reclassified as unsecured debt in its bankruptcy filing.

The bonds, which pay a 6.875 percent coupon, now trade at $1.03 on the dollar because United has emerged from bankruptcy. They represented about 1.5 percent of the fund's assets in of June.

Metzold invested in tobacco bonds as prices plunged in 2003, when an Illinois court awarded $10 billion in damages to smokers of so-called light cigarettes. He stopped adding to those positions once they rallied after bankruptcy threats receded and tobacco companies won victories in class-action lawsuits.

The Eaton Vance fund bought tobacco bonds issued by New Jersey in 2003 when they were trading at an average price of about 86 cents on the dollar. The bonds, which pay a 6.75 percent coupon, now cost about $1.14.

Metzold's fund has Morningstar's highest rating of five stars. The fund has a Sharpe ratio of 1.65, compared with 0.37 for competing funds. A higher Sharpe ratio means better risk-adjusted returns.

"The key here is that Tom Metzold has an uncanny ability to be effective with these bets," said Morningstar analyst Eric Jacobson.

Metzold has 11 percent of the fund in industrial-development bonds, which are issued by local authorities to finance construction of factories and manufacturing plants.