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Bond Fund —
Bonds held up better than stocks in a challenging quarter
3rd Quarter, 2015
"We believe that the global economy is unable to take very sharp hikes in rates, and as a result, the Federal Reserve will take a slower and more careful approach toward raising rates than it has in the past. "
– Pacific Investment Management Company LLC

Investment grade bonds generated modest returns in the third quarter of 2015, with the Barclays U.S. Aggregate Bond Index gaining 1.23%. By comparison, below-investment-grade bonds, as measured by the BofA Merrill Lynch U.S. High Yield Index, substantially underperformed their investment grade counterparts, generating a quarterly return of -4.90.
The Harbor Bond Fund returned -0.30% during the quarter, underperforming the Barclays U.S. Aggregate Bond Index which gained 1.23%. Detractors from relative performance in the third quarter included an underweight to U.S. securities and a short position at the front of the U.K. yield curve in a quarter when U.K. rates fell. Within emerging markets, exposure to local rates in Mexico detracted as they underperformed U.S. rates. The Manager’s allocation to agency mortgages, which underperformed like-duration Treasuries, also hindered relative returns.
On the positive side, the Fund’s underweight to investment grade corporates proved beneficial as the sector lagged like-duration Treasuries. Interest rate exposure in Italy and Spain added to performance over the quarter as yields fell following news of the Greek debt resolution and a positive eurozone growth outlook. The Manager’s currency positioning contributed positively to relative performance. At quarter-end the Fund held its long U.S. Dollar bias versus a basket of currencies within developed markets and emerging market currencies. So, the Manager held a short within the Japanese Yen, the Euro, and a basket of Asian emerging currencies. The Fund is managed by Scott Mather, Mark Kiesel, and Mihir Worah of Pacific Investment Management Company, LLC (PIMCO).
PIMCO’s comments were made in an October 14, 2015 interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended September 30, 2015, unless otherwise indicated. All references to year-to-date are for the period January 1, 2015 through September 30, 2015.

Interview Highlights

Economic Backdrop
Economic growth in the U.S. remained robust. The labor market continued to show signs of improvement with the unemployment rate falling to 5.1%. The benefits of a strong labor market were also evident in second quarter gross domestic product (GDP) data, which was revised up to 3.7%, driven by gains and personal spending. Internationally, focus turned from Greece to China’s declining stock market and devalued currency. The devaluation and uncertainty surrounding China's ability to effectively transition to a different and slower growth model quickly spread through financial markets, sparking a sell-off in emerging market currencies and commodities and a drop in inflation expectation.
Monetary Policy
About 40 central banks worldwide have lowered their policy rates, and we are anticipating potential further monetary easing. Most of these banks are striving to boost economic growth and also avoid potential deflation. As for the Fed, we do expect that the Federal Open Market Committee will start raising rates. December or March are possible starting points. We believe that the global economy is unable to take very sharp hikes in rates, and as a result, the Federal Reserve will take a slower and more careful approach toward raising rates than it has in the past.
Currency Positioning
The anticipated divergence in monetary policies between the U.S. and the rest of the world has opened up potential investment opportunities. We've historically been modest users of currency trades as a source of return. However, monetary policy effects have been most clearly identified by the markets in this area, and these instruments have had the most opportunity to move. As a result, we chose to use the currency markets, rather than the interest rate market, to express our views.
We continued to favor Treasury inflation-protected securities (TIPS) in the portfolio. Exposure remained consistent over the quarter, with TIPS as the majority of the portfolio’s Treasury component. TIPS detracted from performance for the quarter, because they underperformed nominal Treasuries as breakeven inflation levels fell to multi-year lows on falling oil prices and lower inflation readings.
Reacting to Rising Rates
It’s impossible to say whether we would change the Fund’s risk posture as a result of rising rates before we know exactly what the environment looks like. If there are ample opportunities in corporate bonds, then we may increase our exposure in that area. Otherwise, we would likely try to position the portfolio in an appropriate way to benefit from rising rates, which we can do as an active Manager.

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.