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Bond Fund —
Fund outperforms during a challenging and turbulent Q2 environment
2nd Quarter, 2015
"Consistent with our long-term outlook, we expect the pace of interest rate increases to be slower than past cycles. We have differed from the markets, but it appears that the consensus is starting to price in our views. "
– Pacific Investment Management Company LLC

Investment-grade bonds declined in the second quarter of 2015, with the Barclays U.S. Aggregate Bond Index losing -1.68%. By comparison, below-investment-grade bonds, as measured by the BofA Merrill Lynch U.S. High Yield Index, were essentially flat for the quarter, dropping -0.05%.
The Harbor Bond Fund lost -1.60% during the quarter, slightly outperforming the Barclays U.S. Aggregate Index. The major contributors to performance in the second quarter were positive sector and security selection decisions. Most helpful was an off-benchmark position in Treasury Inflation Protected Securities (TIPS). PIMCO has viewed the inflation protection offered by these securities as attractively priced considering that the U.S. Federal Reserve has indicated that one of its goals is for inflation to rise. Sector and security decisions also helped within the credit areas. Specifically, the Fund was underweighted in the underperforming investment-grade credit sector, and it maintained a position in high yield bonds, which outperformed.
On the negative side, the Fund’s interest rate and currency positioning detracted from performance. The largest detractor from an interest rate perspective was a position in German bunds, which sold off on valuation concerns as well as improved economic data in Europe. Meanwhile, the Fund has continued to have a long position in the U.S. Dollar and a short position in the Euro, which also hurt as the Dollar’s recent strengthening trend abated during the quarter. The Fund is managed by Scott Mather, Mark Kiesel, and Mihir Worah of Pacific Investment Management Company (PIMCO).
PIMCO’s comments were made in a July 15, 2015 interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended June 30, 2015, unless otherwise indicated. All references to the year-to-date are for the period January 1 through June 30, 2015.

Interview Highlights

Economic Backdrop
The U.S. economy continued to show signs of strength over the second quarter. First quarter GDP was revised upward, nearly every labor market indicator pointed to sustainable growth, and we also saw high levels of consumer confidence. While Europe’s economy also showed signs of improvement, they were overshadowed by uncertainties surrounding Greece. Finally, China reported strong economic growth once more, especially relative to the rest of the world, but equity market volatility may prove to be a headwind for the Chinese economy. Bond markets exhibited higher volatility, and the overall backdrop was challenging for high quality bonds.
Main Long-Term Views Maintained
For about a year, we have expressed the view that the future of monetary policy will be based on a significantly lower neutral rate. When the economy is running at a normal pace, we expect that the Federal Reserve will be able to raise their rates up to about 2% rather than the historical average of 4%. This is because higher indebted levels and higher rates of interest could potentially start slowing down the economy in a way that would be damaging. Importantly, we also continue to believe in a convergence of growth rates between developed and emerging markets and a more stable banking system due to more regulation.
Rate Hike Expectations
Our base case is that the Fed will raise rates in September, because of improvements in the labor markets and the central bank will continue to hike rates to get some maneuvering room for monetary policy should there be another slowdown in the economy. Consistent with our long-term outlook, we expect the pace of interest rate increases to be slower than past cycles. We have differed from the markets, but it appears that the consensus is starting to price in our views.
TIPS Stake Remains
We are maintaining our sizable allocation to TIPS, with the view that expectations for inflation are still very low. The Fed is targeting inflation of 2%, and history suggests that it’s very likely that inflation could overshoot at some point. Meanwhile, the TIPS market continues to price in less than 2% inflation, providing an attractive entry point for investors.
Strong Dollar View
As in previous quarters in the recent past, we are long the U.S. Dollar and short the Euro and select other currencies. This positioning reflects our belief that the U.S. Dollar continues to be a safe haven asset and will continue to appreciate as a result of rising rates in the U.S. As mentioned, the Dollar weakened versus the Euro in the quarter, due to continued uncertainty about the start and pace of rate hikes. However, we continue to favor the Dollar given our long-term views.

Performance data shown represents past performance, which is no guarantee of future results. Current performance may be higher or lower than the past performance data shown. Investment returns and the value of an investment will fluctuate, and an investor's shares, when sold, may be worth more or less than their original cost. You can obtain performance data current to the most recent month-end (available within seven business days after the most recent month-end) by calling 800-422-1050 or visiting

Performance figures discussed reflect that of the institutional class shares.

The views expressed herein are those of the portfolio manager at the time of the interview and may not be reflective of their current opinions or future actions.  These views are not necessarily those of the fund company and should not be construed as such.

This information should not be considered as a recommendation to purchase or sell a particular security and the holdings or sectors mentioned may change at any time and may not represent current or future investments.