After Detroit filed for bankruptcy last summer, portfolio managers at Eaton Vance municipal bond funds saw a gem hidden in the plumbing of the beleaguered Midwestern city.
As the prices of 30-year bonds backed by Detroit's water and sewer system plunged, the Boston-based firm swooped in to become the top investor in them.
The bet paid off as the Detroit bonds recovered to nearly full value, helping the $763 million Eaton Vance High-Yield Municipal Income Fund post a 10.76 percent year-to-date return. That is nearly double the 5.39 percent average return across nearly 600 municipal funds tracked by Lipper Inc, and ranks it No. 9 among U.S. municipal bond funds.
Eaton Vance's payoff is just one example of the recovery of municipal junk bond funds so far this year, after a tough 2013.
Using plays on land, low borrowing costs, and distressed debt, junk bond funds are the best performers in the municipal category so far in 2014. They've rebounded from last year's credit panic when Detroit's bankruptcy and Puerto Rico's chronic fiscal woes triggered nearly $60 billion in net withdrawals by investors from muni bond funds.
Eaton Vance portfolio manager Tom Metzold said the bet on Detroit was no sure thing, but that risk was limited because the city's water and sewer authority provides services well beyond city limits. Repayment of the bonds isn't tied just to Detroit residents, but to an area that includes about 50 percent of Michigan's population - much of it in a lot less fiscal distress than Detroit itself.
Prices on the bonds dropped to 77 cents on the dollar late last year, only to rise to about 99 cents this month. In February, Detroit said water and sewer bondholders would receive full recovery, while investors in other bonds issued by the city would receive only between 10 cents and 30 cents on the dollar.
Funds run by Eaton Vance are not only enjoying price appreciation on the water and sewer bonds, they also get an annual coupon rate of 5.25 percent. Eaton Vance funds and investments strategies owned about 36 percent of the $224 million bond issue, as of March 31, according to Thomson Reuters data.
Eaton Vance bought some of the bonds last year at around 90 cents on the dollar, Metzold said. It bought more earlier this year as the price of the bonds traded between 77 cents to 84 cents on the dollar, providing annual yields of about 6 percent to 7 percent.
And he stressed that the firm isn't only looking for a short-term profit.