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Bond Fund —
Bonds declined against a backdrop of falling commodity prices
4th Quarter, 2015
"We are currently not seeing a recession on the horizon. We have a relatively benign and positive view on the cyclical horizon for both the world economy as a whole and individual regions. "
– Pacific Investment Management Company LLC

Investment grade bonds fell during the fourth quarter of 2015, with the Barclays U.S. Aggregate Bond Index ending at -0.57%. Below investment grade bonds, as measured by the BofA Merrill Lynch US High Yield Index, substantially underperformed their investment grade counterparts, generating a quarterly return of -2.17%. Investment grade bonds benefited from having lower exposure to commodities related sectors than their high yield counterparts.
The Harbor Bond Fund returned 0.06% during the quarter, outperforming the Barclays U.S. Aggregate Index. Contributors to relative performance in the fourth quarter included an underweight to U.S. securities, a short position at the front of the U.K. yield curve, and some exposure to short-term rates in Germany. Within emerging markets, exposure to local rates in Mexico also contributed to performance. The Manager’s security selection in non-agency mortgage holdings was positive for performance. Within the investment grade corporate bond sector, an overweight to Financials also provided a relative boost. The Manager’s allocation to municipal bonds contributed as well. Treasury Inflation-Protected Securities (TIPS) were positive for the period.
On the negative side, the Manager’s security selection in agency mortgages hindered relative returns. Though the Fund was overweight agency mortgages, which outperformed like-duration Treasuries, this positive was not enough to offset the weak security selection in the sector. Finally, outsized negative returns in commodities drove negative relative returns in the high yield sector on spread widening.
PIMCO’s comments were made in a January 15, 2016 interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2015, unless otherwise indicated. All references to year-to-date are for the period January 1, 2015, through December 31, 2015.

Interview Highlights

Economic Backdrop
After a very volatile third quarter, the fourth quarter brought some relief as economic fundamentals strengthened and sentiment stabilized. U.S. economic indicators continued to suggest a healthy pace of growth, especially in the labor market, where unemployment rates fell further towards pre-crisis lows. U.S. domestic demand remained strong, driven by consumer spending, which was supported by job gains and rising consumer confidence. Amid signs that job gains may be translating into income gains, inflation expectations rose modestly, despite new lows in oil prices. This positive tone allowed the U.S. Federal Reserve to begin reducing monetary accommodations. After no action in September, the Federal Reserve lifted the policy rate by a quarter percent in a unanimous vote in December. Markets were well prepared and interpreted the hike to be a vote of confidence in the economic recovery. As such, U.S. yields, particularly at the front end, rose.
Currency Positioning
The anticipated divergence in monetary policies between the U.S. and the rest of the world has opened up potential investment opportunities. As such, at quarter end the Fund was long the U.S. Dollar to a basket of currencies. In developed markets, we were short the Japanese Yen and the Euro. And in emerging markets, the Fund was short a basket of Asian emerging market currencies. Overall, this strategy was positive for performance during the quarter, though a long position to the Russian Ruble detracted slightly.
Divergence in Monetary Policy
Central banks around the world are now pursuing very different paths. Most notably, the U.S. raised interest rates in December. We also expect Mexico, Brazil, and South Africa to tighten their monetary policies. On the flip side of the coin, the European Central Bank, Bank of Japan, and People's Bank of China are all seeking more accommodative policies. In 2016, we expect that this divergence of policy prescriptions will continue to lead to opportunities for investment, both in the rates and currency markets.
Optimism on Economic Growth
After the shock we saw in the third quarter largely based on fear surrounding a slowdown in China’s economy, the U.S. now seems to recognize that growth around the world isn't all that bad. Through the end of 2015, we continued to see positive growth in most parts of the world economy. We are reassured that we currently do not see any of the signs of the usual causes for recession on the horizon—no overheating of the economy, or overinvestment. We have an optimistic view on the cyclical horizon for both the world economy as a whole and as individual regions.

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

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