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Darling falls out of favor

Eaton Vance Corp., the conservative Boston investment firm, looked like a company situated in exactly the right spot for the times. Then the earth moved, and some its fans aren't so sure anymore.

Eaton Vance, which had enjoyed decades of low-profile success, became a kind of Wall Street darling in recent years. Though it manages all sorts of funds, the company's reputation among cautious, income-oriented investors and its ability to create popular products helped propel Eaton Vance stock by an average of nearly 35 percent a year over three-year period ended June 30.

But the market turbulence of the past two months, and what it did to Eaton Vance's business, made investors rethink the stock.

Merrill Lynch, a brokerage that does lots of business with Eaton Vance, cut its rating on the company's stock from "neutral" to "sell" two weeks ago. The next week, JP Morgan Securities downgraded it, as well, effectively switching signals from buy to sell.

The stock "had been our favorite investment idea," wrote JP Morgan analyst Kenneth Worthington. "We now think Eaton Vance could succumb to small but meaningful issues." He didn't mean Eaton Vance was in any serious danger, but new problems came with the potential to hurt sales and earnings.

Analysts at both Merrill Lynch and JP Morgan said Eaton Vance was particularly vulnerable because its stock had become so expensive. Those shares traded at a premium to other investment company stocks because Eaton Vance, which manages $154 billion, built such a strong record growing its business. Wall Street had seen a bona fide growth company, which increased profits by 33 percent in its last quarter, and paid accordingly.

The shares hit a record of $47.69 on July 13, then started to slump. They had fallen to $40.45 by the time JP Morgan advised clients to sell and fell to $37.34 by 4 p.m. last Wednesday. The stock finished last week at $38.62.

Investors worried about Eaton Vance because market volatility had cast doubt on the growth prospects of three important market niches.

Its funds that invest in bank loans own assets that few people are interested in buying at the moment. Prices of closed-end income funds, a big source of new business, nose-dived. Finally, performance of the company's well-regarded municipal bond funds abruptly went from top-shelf to bottom of the barrel.

Eaton Vance executives see the same problems stirred up by a volatile market but don't think they will inflict any real damage.

"I'm not going to say it will last forever, but we've got a lot of momentum in our business," says president Tom Faust. "We think we've got a portfolio built for performance in all market environments."

Bank loan funds may be a nonstarter for retail investors, but Faust says Eaton Vance is considering a new product for institutional investors who realize those relatively safe credits have been bashed to bargain prices. He agrees the market for new closed-end funds has dried up but thinks it could be back before long.

Faust says Eaton Vance's terrible recent performance in municipal bond funds occurred when normal hedges failed to protect against more vulnerable longer-duration investments. He thinks investors will rely on longer-term rankings, which still place Eaton Vance funds at the top of their class.

Eaton Vance may well come out of the market's turbulence on its feet, but that doesn't necessarily mean investors will see it as a fast-growth company again. That kind of confidence, once shaken, is hard to regain.

BOSTON CAPITAL BLOG Steven Syre is a Globe columnist. Read his daily blog at boston.com/business. He can be reached at syre@globe.com.

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