Eaton Vance Corp. is prying its way into banks by promoting unusual mutual funds that invest directly in noninvestment-grade corporate loans.
The Prime Rate Reserves, as the funds are known, purchase portions of corporate loans made by banks. The funds then pass on to investors the interest that is paid on the loan by the corporation.
But some observers think bank customers have a hard enough time understanding the risks of bond and stock funds without having to wrestle with the complications of an entirely different type of investment.
Michael Stout, an analyst of closed-end-funds for Morningstar Inc., characterized this style of mutual fund as "one of the most obscure things in the fund universe. I don't know anybody but analysts who fully understand them."
Eaton Vance insists even first-time mutual fund investors can comprehend the way the fund works if a broker presents the particulars properly.
"There's a learning curve, you may have to explain it more than once, but if we can show a client the benefits of the fund, it will work as a complement to a bond fund or certificate of deposit," said Brian Jacobs, senior vice president, and head of the fund company's sales through banks.
The key selling point of Prime Rate Reserves portfolios is that the value of the principal isn't as sensitive to interest rate movements as bonds in a typical long-term fixed income fund. That's because the portfolio invests in floating rate loans, which have yields that reset frequently, diminishing interest rate risk.
Indeed the net asset value has remained relatively stable since the portfolio was established in 1989.
"If you add it to a portfolio with bond funds, you lower the overall volatility that is caused by the bond fund," Mr. Jacobs said.
Mr. Jacobs said the funds will produce a yield at least two percentage points above short-term investments such as certificates of deposit or money market funds.
The fund achieves that yield advantage by purchasing portions of loans from Fortune 1,000 companies whose debt ratings are below investment grade. Those companies are required to pay higher interest rates on loans than investment grade companies.
The risk is that these companies could default on their loans. Junk bonds, which wreaked havoc on investors in 1989 and 1990, invest in corporations with low credit ratings. Eaton Vance's fund is less risky because it invests in higher grade companies than most junk bond funds do.
Another issue for investors is that the funds aren't very liquid. They are a hybrid of closed-end and open-end funds, so investors can put money into the fund, but they can only cash out once a quarter.
The big question is will bank customers take to these funds once they learn the funds are so similar to junk bond funds?
"Bank customers probably won't like it if they're used to CDs," Mr. Stout said. "They'd be going from one spectrum of credit quality to another."
Still, Eaton Vance has found success promoting these funds as complements to CDs and bond funds, said Brian Jacobs, a senior vice president who heads the company's sales through financial institutions.
Mr. Jacobs said sales this month jumped 120% over the same period last year, largely due to the Prime Rate portfolio, which accounted for half of Eaton Vance's mutual fund sales through banks last month.
