Eaton Vance Corporation
Eaton Vance Corporation
24 Federal Street
Boston, Massachusetts 02110
Sales: $1.6 billion (1995)
Stock Exchanges: NASDAQ
SICs: 6282 Investment Advice
The origins of Eaton Vance Corporation date to the activities of Charles F. Eaton Jr., founder of Eaton & Howard Inc., a Boston investment house. Born in Princeton, Maine, on February 3, 1898, Eaton graduated from Phillips Exeter Academy in 1919 and from Harvard University in 1923. From 1922 to 1924 he served as assistant secretary treasurer of First National Corporation in Boston. In 1924, he left First National to found Eaton & Howard, Inc., becoming president and director of the investment firm in 1931.
Under Vance’s direction, the company created and managed several investment funds, including the Stock Fund, founded in 1931 to invest primarily in corporate common stocks. In 1932, the company formed two funds, the Balanced Fund that sought capital growth through a blend of holdings in bonds and preferred and common stock, and the Income Fund as a general investors trust. In 1962, Eaton & Howard established the Growth Fund, which invested principally in common stocks of aggressive growth companies. The company also created the Special Fund in 1967 as a diversified fund comprising securities that appeared to have potential for substantial capital appreciation. To expand its market niche, in 1975 the Special Fund acquired the Foundation Stock Fund, Inc. of St. Louis, Missouri.
On May 1, 1979, the company was acquired and incorporated by Vance Sanders & Company, thus becoming Eaton & Howard, Vance Sanders Inc. Founder Eaton Vance remained as the new company’s vice chairman. On February 20, 1981, the reconstituted company then formed Eaton Vance Corp. as a holding company, and incorporated in the state of Maryland to operate other businesses in real estate, oil and gas, precious metals, and investment counseling services.
Growth During the 1980s
By late 1983, the first year of the historic bull market, the firm’s investment and mutual fund subsidiary had grown to manage 23 mutual funds and various individual and institutional accounts totalling $2.3 billion in assets. The company’s success in the investment business rode the crest of the mutual fund boom. For the year ended August 1983, the total return for the mutual fund industry, including 538 stock and bond funds, averaged 56 percent. With the exception of the October 1987 stock market debacle, the bull market continued throughout the 1980s and into the 1990s.
The passage of the Tax Reform Act of 1984, however, posed substantial difficulties for the mutual fund industry’s tax-managed funds by closing several tax loopholes. Although six leading industry managers abandoned their tax sheltering funds, converting them to conventional funds, Eaton Vance, the largest tax-managed fund with $499 million in assets, continued to seek tax protection for shareholders. Tax-managed funds operated by converting ordinary income from dividends into capital gains taxable at lower rates and only when shares were redeemed. As a result, they were taxed as corporations instead of as managed investments. Corporate taxes were then avoided through trading maneuvers and using the 85 percent dividend exclusion provision. Further, the funds kept all earnings, which allowed shareholders to avoid taxable dividends.
The 1984 tax law attacked these strategies in several ways. The law allowed the 85 percent dividend exclusion only when investors held stock for 46 days, instead of 16, and prohibited the exclusion if the fund borrowed money to purchase the stock. More prohibitive, the new tax law exacted an accumulated earnings tax on investment firms and disallowed trading losses as a deduction from the taxes. Although this provision served to kill many tax-managed funds, Eaton Vance decided to continue its Tax-Managed Trust.
In 1987, the company’s group of funds outpaced many of its competitors despite the October 19th stock market plunge. In spite of record earnings, the company’s stock tumbled from a high of 32 in March to just 13 in late October 1987. Nevertheless, like other fund distributors the company’s success stemmed mostly from selling “spread” funds, earning brokers a 4 percent sales commission from Eaton itself rather than from the fund’s shareholders. The company recovered commissions by charging Eaton shareholders a surrender fee when they redeemed shares. The deferred sales commission not only accounted for a substantial portion of Eaton’s pretax income, but also protected its earnings by discouraging redemptions. By 1988, Eaton Vance had more than $6 billion under management.
Throughout the 1980s the rapid growth of the mutual fund industry was accompanied by expansion of municipal bond tax-exempt funds. In 1988, investors poured $4.2 billion into long-term national and single-state tax-exempt funds, while selling $21.5 billion of mutual funds, including $5.7 billion of fixed-income funds after the 1987 stock market plunge. The growing popularity of tax-exempt funds stemmed from nervous investors eschewing the stock market following the October 1987 stock market crash as well as others seeking tax relief or fearing rising state and federal income taxes. As a result of these trends, Eaton Vance’s small Municipal Bond Fund L.P. grew about 20 percent in 1987 to $63 million.
Eaton Vance organized its Municipal Bond Fund as a limited partnership, a unique structure that provided fund holders added tax benefits. Whereas most funds established themselves as corporations and could only deduct losses against gains, Eaton Vance could pass these losses directly to fund holders, providing them a loss to offset any capital gain. This benefit allowed shareholders to claim lower taxes on capital gains. In addition, Eaton Vance’s Municipal Bond Fund permitted investors to withdraw their principal investment without adverse tax consequences. In the late 1980s, the Municipal Bond Fund rivaled stock equity returns, posting a 33.89 percent one-year total return; a 79.7 percent return for three years; and 79.7 percent for five years. The fund invested mainly in long-term revenue issues with an average maturity of 26 years. By 1988, Eaton Vance also had more than $6 billion under management.
In 1989, Eaton Vance’s Prime Rate Reserves, the largest of new funds organized to purchase bank loans, suspended sales temporarily in order to invest a growing pool of assets. The fund’s principal underwriter, Eaton Vance Distributors, announced that from almost $1.6 billion in assets, only $960 million had been invested. The closed-end fund engaged in several high-return, high-risk leveraged loans, requiring a minimum investment of $5,000. The inability to invest its assets stemmed primarily from the time needed to close on loan participation, which typically took several weeks.
In addition, like other prime rate funds that invested in bank loans, the company’s Prime Rate Reserve failed to yield returns matching the prime lending rate. To close the gap, Eaton Vance innovated a method enabling the fund to boost its yield. In 1990, the company began leveraging the $2 billion fund by selling debt obligations at low interest rates and reinvesting the proceeds in higher yielding bank loans. The difference between the two rates increased the fund’s yield. A large share of the fund’s assets comprised highly leveraged transactions that earned 1.5 percent over the prime rate, or over 2.5 percent over the London interbank rate. In addition, Eaton Vance formed a $300 million credit-enhanced commercial paper program guaranteed by the fund’s assets. Although mutual funds sometimes applied preferred stock and bank loans for leveraging returns, Prime Rate Reserves became the first to use commercial paper. The company’s vice-president, Richard D’Addario, responsible for structuring the deal, believed the fund could obtain higher rates in the commercial paper market than in using bank lines. The use of commercial paper allowed the fund to borrow at cheaper rates, both enhancing the yield and allowing liquidity.
Good News, Bad News, the 1990s
By the late 1980s, Eaton Vance’s core products included 34 low-risk, tax-free funds, making the company a giant in the industry. In 1990, the company began marketing its funds through banks, accounting in 1992 for about 15 percent of its $3 billion in total sales, or $450 million. By 1993 more than 60 banks were selling Eaton Vance funds. Because the company did no advertising, it relied on a cadre of 23 staff members to work with banks and provide extensive customer education. This initial success stemmed largely from Eaton Vance’s fee structure. Rather than up-front load charges, customers could pay deferred sales charges, levied only when the funds were withdrawn.
In 1992, Eaton Vance affiliated with Lloyd George Management with the introduction of the Greater China Growth Fund. With offices in Hong Kong, London, and Bombay, Lloyd George Management enabled Eaton Vance to distribute mutual funds globally. Eaton Vance initially purchased a 6 percent stake in Lloyd George, which it later increased to 24 percent in 1995.
The company’s mission is to create, manage, and market innovative investment products offering superior performance.
The company’s primary business is creating, marketing, and managing mutual funds and providing management and counseling services to institutions and individuals. Eaton Vance Corporation also manages investments in real estate and precious metals. The company operates its management investment and counseling business through two wholly owned subsidiaries, Eaton Vance Management and Boston Management and Research. In addition, Eaton Vance Distributors, Inc. markets and sells the Eaton Vance funds.
By 1993, Eaton Vance had doubled its assets under management in five years to $12 billion. Although impressive, this growth was slightly less than similar companies in the mutual fund industry. Nevertheless, earnings improved considerably from a low of 98 cents a share in 1989 to $2.49 a share in 1992, and operating income recorded a similar steep increase. Despite these gains, the company ran into difficulty with the Internal Revenue Service (IRS) over its fund sales and management fees. More than 90 percent of fund sales and 60 percent of management fees came from its primary product—B shares or mutual funds sold by brokers without a commission. The company paid brokers a 4 percent fee up-front, and then attempted to recover these costs from investors through a 1 percent annual charge, or up to 6 percent if they redeemed their shares early.
The company’s tax problems stemmed from attempts to increase cash flow to offset these up-front cash payments to brokers. If a fund company recorded commission payments as normal business expenses, they could effectively erase earnings. Although this strategy might prove useful for cutting tax bills, it offered little in attracting new investors. As a result, Eaton Vance and similar firms sought to capitalize and amortize broker payments for reporting purposes, while expensing them for tax purposes. In 1992, the company reported an operating loss to the IRS, adding about $16 million beyond the $63 million in deferred taxes listed as liabilities on its balance sheet. The company then tried to use the $16 million for broker fees, money that otherwise would have gone to the IRS. About 29 other investment firms also offered B shares, nine of which netted more than $1 billion in sales. Along with Eaton Vance, these funds also faced potentially adverse financial consequences from the IRS.
Restructuring and Globalization
In late 1993, Eaton Vance became the first mutual fund company to convert its entire fund family to the “hub-and-spoke” structure. Developed by Signature Financial Group, the new structure allowed banks to attach their own names to the funds. The company hoped banks would pursue this option instead of offering their own proprietary products. With the hub-and-spoke structure, the company managed fund assets as a single pool, or hub. Eaton Vance offered shares in funds, or spokes, that invested in the pool at different prices. Although each spoke fund had a board of directors, they shared the investment objectives of the hub. The structure enabled the company to cut expenses by managing assets as a single pool. To direct the hub-and-spoke program, the company appointed William J. Kearns, formerly a senior vice-president of Fidelity Investment’s institutional department. Kearns believed the program offered banks private labelling under their own names at low cost, as well as enhanced revenue and distribution. Further, it provided banks a means to enter new market niches that they might not be able to do on their own. Nevertheless, luring banks to place their own names on the funds instead of offering their own proprietary products had disadvantages, particularly the loss of investment management fees.
Under the new plan, in 1995, Eaton Vance began selling new specialty funds through banks, offering two new portfolios that invested in stocks in global information age companies in the entertainment, telecommunications, and personal computers industries. The company managed the funds together with Hong Kong-based Lloyd George Management. Primarily known for its fixed-income portfolios, the company sought to distinguish itself from large fund companies that already dominated the banking arena by selling a variety of new specialty funds. In addition, Eaton Vance began offering funds that invested in corporate loans or non-investment-grade municipal bonds. The two new funds—Traditional Age Fund and Marathon Information Age Fund—invested primarily in large and small-capitalization companies. Eaton Vance offered these portfolios to the 70 banks that were already selling its other funds. About 25 percent of the company’s fund sales through banks came from fixed-income funds, and another 60 percent derived from Eaton Vance’s Prime Rate Fund. The company also introduced and marketed to banks a new municipal bond fund, which invested 30 to 40 percent of its portfolio in non-investment grade bonds.
In the same year, Eaton and Vance spun off its 77.3 percent ownership in Investors Bank and Trust Company to the firm’s shareholders. The move allowed the company to free its $128 million-asset banking subsidiary from a federal regulation that substantially restricted its growth and compelled it to give more than $400 million in lines of credit to competitors. The divestiture also permitted the bank to earn greater value for Eaton and Vance’s shareholders than it otherwise could as a restricted subsidiary. Behind the company’s move was a little known federal law, the 1987 Competitive Equality Banking Act, limiting subsidiaries of nonbank holding companies to 7 percent annual growth in balance sheet assets. The law also curbed such banks from providing new products, thus prohibiting Investors Bank and Trust, with $75 billion in assets, from offering commercial banking services.
Despite restructuring under the hub-and-spoke, by 1996 the plan was faltering, and Kearns left Eaton Vance for Boston-based Standish, Ayer & Wood, Inc., an institutional money manager. The company’s program suffered from the specialized nature of its assets or portfolios, mostly municipal funds that numerous banks already offered on their own. Nevertheless, other hub-and-spoke plans offered by Citicorp, Chase Manhattan Corp., Bankers Trust New York Corp., and J.P. Morgan succeeded in capturing assets from smaller banks and brokerage firms. On the whole, the hub approach proved enormously profitable for the industry, capturing about $59.4 billion of assets nationwide, or 2 percent of all mutual funds assets in the country. As a result, the company elected to stay with the plan for the foreseeable future.
As 1996 unfolded, the strong American economy presaged impressive investment returns from both the U.S. stock and bond markets. In addition, the company anticipated positive returns from overseas markets, which would benefit Eaton Vance’s international equity funds—particularly its Greater China, Greater India, Emerging Markets, and Information Age funds. To expand operations further, the company resurrected a growth and income fund in 1996 after 30 years of dormancy, seeking to capitalize on investor interest in stock funds. The company, managing $14.7 billion in assets, limited portfolio turnover to keep capital gains from eroding returns. By the mid-1990s, equity funds accounted for a growing share of mutual funds sales. As a result, companies specializing in bonds began feeling pressure to diversify their products or be shut out of banks and brokerage firms. Despite reopening its “tax efficient” equity fund, the company still maintained about 60 percent of its assets in domestic bond funds versus 17 percent in stock funds.
The company’s Northeast Properties, Inc. owned 670,000 square feet of income producing real estate in Massachusetts, New Hampshire, and New York. Revenue from these properties accounted for about 2 percent of the company’s total revenue in 1995. In addition, Eaton Vance participated in the development of gold mining properties as a limited partner in two gold mining partnerships, VenturesTrident, L.P. and VenturesTrident II, L.P. The company held a 28 percent interest in VenturesTrident L.P. and a 19 percent interest in VenturesTrident II, L.P. In 1995, however, the two gold mining partnerships produced losses of $1.4 million, resulting primarily from fluctuations in portfolio valuations.
Through its two principal subsidiaries, Eaton Vance Management and Boston Research Management and Research, the company provided investment advisory and administrative services to 154 funds and more than 953 separately managed accounts. The company’s portfolio managers made investment decisions for most of these funds. Lloyd George Management, however, made investment decisions for Eaton Vance’s ten global equity funds. The company employed a portfolio management staff consisting of 39 managers and analysts with substantial experience in the securities industry. The company held investment advisory agreements with each of the funds, which provided for fees based on the management services rendered.
The company’s success has resulted from its ability to develop and offer new funds, as well as to increase assets of existing funds. Nevertheless, Eaton Vance has faced substantial competition in all aspects of the industry. The company’s ability to market investment funds will continue to be critically reliant on access to distribution networks of national and regional securities dealer firms, which also typically provide competing managed investment portfolios. In addition, few obstacles have served to inhibit entry by new investment management firms. As a result, throughout its history Eaton Vance has confronted an ever-increasing number of investment products sold to the public by investment dealers, banks, insurance companies, and others that sell a range of stock, bond, and securities products.
Eaton Vance Management; Boston Management and Research; Eaton Vance Distributors, Inc., Northeast Properties, Inc.
“Advance for Eaton Vance?” Forbes, February 8, 1988, pp. 176–177. Eaton, Leslie, “2 Good to B True?” Barrons, April 12, 1993, pp. 45–46.
Epstein, Jonathan D., “Eaton Vance Considers Spinoff of Trust Unit,” American Banker, March 24, 1995, p. 17.
Holliday, Kalen, “Eaton Vance Betting on Hub-and-Spoke,” American Banker, August 26, 1993, p. 15.
Kapiloff, Howard, “After Misfire, Exec Takes Hub and Spoke Plan to Boston’s Stanish Ayer,” American Banker, June 7, 1996, p. 10.
——, “Bond Fund Specialist Eaton Vance Revives a Stock Fund,” American Banker, May 21, 1996, p. 20
——, “Eaton Vance to Stick with Hub and Spoke Offering Despite Lack of Interest, American Banker, March 5, 1996, p. 7.
Horowitz, Jed, “Eaton Loan-Buying Fund Halts Sales Temporarily,” American Banker, October 20, 1989, p. 11.
Lipin, Steven, “Eaton Vance’s Prime Rate Fund Finds Innovative Way to Boost Yield,” American Banker, October 5, 1990, p. 18.
Moore, Michael O’D, “Tax-Free Funds Giant Sees Big Sales at Banks,” American Banker, March 12, 1993, p. 12.
Walbert, Laura, “Damn the Torpedoes,” Forbes, November 19, 1984, p. 356.
—Bruce P. Montgomery