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Bond Fund —
Fund outperforms benchmark as bond market advances in Q1
1st Quarter, 2015
"Our expectation is that consumption growth in the United States will be relatively robust, supported by a strengthening labor market. "
– Pacific Investment Management Company LLC

Investment-grade bonds generated positive results for the first quarter of 2015, with the Barclays U.S. Aggregate Bond Index posting a return of 1.61%. The index is a measure of the broad taxable U.S. bond market. By comparison, inflation-indexed bonds returned 1.42%, as measured by the Barclays U.S. TIPS Index, while speculative-grade bonds, as measured by the BofA Merrill Lynch US High Yield Index, returned 2.54%.
The Harbor Bond Fund posted a return of 2.10% for the quarter, outperforming its Barclays U.S. Aggregate Bond Index benchmark. Longer-term, the Fund also outperformed the index for the 5-year and 10-year periods ended March 31, 2015, and since the Fund's inception in 1987. The Fund is managed by Scott Mather, Mark Kiesel, and Mihir Worah of Pacific Investment Management Company (PIMCO).
Currency positioning was the biggest contributor to Fund performance relative to the benchmark in the first quarter, the PIMCO team reports, as the portfolio benefited from a strengthening U.S. Dollar against the Euro and Japanese Yen. Other positive contributors included investments in developed markets outside the U.S., an underweighted exposure to U.S. agency mortgage-backed securities, security selection within investment-grade corporate bonds, and an allocation to high yield corporate debt. U.S. interest rate strategies detracted from performance, as did investments in taxable municipal bonds and U.S. Treasury Inflation-Protected Securities, or TIPS, which underperformed like-duration nominal Treasurys.
PIMCO’s comments were made in an April 14, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2015, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2015.

Interview Highlights


U.S. growth
We expect U.S. growth prospects for the next year or so to be about 2.5% to 3% in real terms, with expected inflation of 1.5% to 2%. Our expectation is that consumption growth in the United States will be relatively robust, supported by a strengthening labor market. We also see a boost in the real income of consumers as a result of low commodity prices. There are some potential negatives as well. We expect that the strong Dollar will slow the pace of export growth which should reduce some of the potential for GDP growth in the United States. Also, we believe that capital spending will be relatively slow because of the decline in oil prices impacting the Energy sector, which has been one of the larger areas of investment over the past few years.
Rate hike expectations
Recognizing first quarter labor strength, the Federal Reserve dropped the word "patient" from its statement when discussing rate hikes. However, since wage and other inflationary pressures remained subdued, the Fed also emphasized that the path of future rate increases will likely be more gradual than in previous cycles. This emphasis, along with concerns over a rapidly appreciating U.S. Dollar, encouraged markets to pare back rate hike expectations for the summer.
Mortgage-backed securities
We are underweight agency mortgage-backed securities on a valuation basis and continue to hold non-agencies. Non-agencies represent one of the few areas in the marketplace still providing an attractive yield. There has been virtually no new issuance in that segment, and we are not reducing any of our allocations there.
Corporate positioning
We have a below-index exposure in corporate securities. If you look at the investment-grade segment, we are selectively trying to make additions to bring the position closer to the benchmark. We also have allocated about 5% to high yield with an emphasis on rising stars – credits that we believe are likely to get upgraded over time to investment-grade ratings.
Overseas exposure
We diversified the Fund's industry exposure outside the U.S. with positions in developed markets such as Italy, Spain, the U.K., and Germany. This strategy was overall positive for performance in the first quarter. Holdings in Italy and Spain were positive as these bonds performed well in response to the European Central Bank's quantitative easing announcement. The positive impact was partially offset by an underweighted exposure to shorter-term rates in the U.K., which rallied.

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 www.harborfunds.com.

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.