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Bond Fund —
Bonds open 2014 with positive returns as rates decline in Q1
1st Quarter, 2014
"Higher growth prospects for the global economy have led us to reduce our underweight to spread sectors. "
– Pacific Investment Management Company LLC

After losing ground in the prior year, investment-grade bonds reversed course in the first quarter of 2014. The Barclays U.S. Aggregate Bond Index, a measure of the broad taxable U.S. bond market, returned 1.84% for the three months ended March 31, 2014. This positive performance followed a decline of -2.03% for calendar 2013. The yield of the 10-year U.S. Treasury note, a reference for mortgage rates and other borrowing costs, closed the quarter at 2.72%, down from 3.03% at the end of calendar 2013. Bond yields fall as their prices rise.
In this environment, the Harbor Bond Fund registered a return of 1.20%, trailing the Barclays U.S. Aggregate benchmark. The Fund continued its long-term outperformance of the benchmark, outpacing the index for the 5-year and 10-year periods ended March 31 and since the Fund's inception in 1987. Bill Gross, managing director, chief investment officer, and founding partner of Pacific Investment Management Company (PIMCO), has managed Harbor Bond Fund since its inception.
The primary detractor from relative performance in the first quarter was the Fund's emphasis on the front-end and intermediate portion of the yield curve, the PIMCO team reports. This prevented the portfolio from benefiting more fully from the decline in longer-dated yields. This was partially offset by interest-rate positioning outside the U.S., as well as holdings in non-agency mortgage-backed securities, high yield corporate bonds, and Build America municipal bonds.
PIMCO’s comments were made in an April 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2014.

Interview Highlights

Improving global growth
Generally speaking we continue to expect stronger growth across the U.S. and Europe. Many of the challenges we saw in 2013 appear to have faded and we now expect to see a pick-up in economic performance globally.
Upward pressure
We expect that Federal Reserve tapering will ultimately produce upward pressure on rates, primarily in the long end of the yield curve, which typically would be the most vulnerable from an interest-rate perspective. That is why we are underweighted in the longer-dated end of the curve.
Portfolio positioning
We are going to be underweight in duration, about a quarter to a half year, and we continue to emphasize the short end of the yield curve while avoiding some of the longer-end exposures. Higher growth prospects for the global economy have led us to reduce our underweight to spread sectors. We continue to be underweight in corporates but only slightly so.
TIPS exposure
We continue to hold TIPS [U.S. Treasury Inflation-Protected Securities] in the portfolio. We are targeting the intermediate segments, which are currently the steepest area of the yield curve and which we believe provide the best return for the amount of interest rate risk we are taking. We continue to hold some of the non-agency positions in mortgage-backed securities given that they provide an attractive incremental yield to the portfolio.
Corporate bonds
Areas that we currently favor in corporate bonds include financial, housing-related, and energy names. These will continue to be primarily investment-grade securities in the shorter to intermediate part of the yield curve, in line with our overall interest rate positioning. We are using high yield bonds very selectively. Our high yield exposure currently is only 1.3% of the portfolio, which is unchanged from end of December.

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.