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Money Market Fund —
Money market returns remain barely above zero in 2013
4th Quarter, 2013
"Our expectation is that in 2015 we'll see some normalization of interest rates, particularly in the front end of the yield curve, which would provide a needed boost to money market returns. "
– Ken O'Donnell

Short-term yields remained at near-zero levels throughout 2013, reflecting ongoing monetary stimulus efforts by the Federal Reserve. The Fed announced in December that it would begin dialing back its $85 billion-a-month bond buying program in January 2014. At the same time, however, the Fed said it would maintain its federal funds target rate in the range of 0.0% to 0.5% and could continue to hold it at that level, even if U.S. unemployment declines below 6.5%.
The BofA Merrill Lynch US 3-Month Treasury Bill Index, a proxy for money market performance, recorded a return of two basis points, or 0.02%, for the three months ended December 31, 2013, and 0.07% for the calendar year. The Harbor Money Market Fund closely tracked the index, with returns of 0.01% for the fourth quarter and 0.08% for the year.
Portfolio Manager Ken O'Donnell says that while short-term interest rates remained low in the fourth quarter, longer term rates rose in response to an improving economic climate and the Federal Reserve policy shift, increasing the slope of the yield curve. O'Donnell notes that, despite their low yields, money market funds in 2013 outperformed most investment grade fixed income funds, which posted negative returns in the rising-rate environment.
Looking ahead, O'Donnell and his team expect further increases in longer term rates in 2014 while money market rates remain anchored near zero. In this environment, the Fund has continued to follow a conservative strategy, investing only in U.S. government and agency securities and maintaining a moderate portfolio duration.
Ken O'Donnell's comments were made in a January 15, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2013, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2013.

Interview Highlights

Competitive returns
Despite unexciting returns, money market funds remain a safe haven and continue to draw interest from investors. At current yield levels, money market funds remain competitive relative to U.S. Treasury bills and other government securities, although they continue to experience competition from longer term bank certificates of deposit. It should also be noted that money market funds outperformed most investment grade fixed income funds in the year 2013.
Possible boost to returns
While we expect money market rates to remain very low throughout 2014, we think we may be seeing the beginning of the end. Our expectation is that in 2015 we'll see some normalization of interest rates, particularly in the front end of the yield curve, which would provide a needed boost to money market returns. It has been a very difficult cycle. Keeping monetary policy rates at near-zero levels has really depressed returns for short-term investors looking for a safe haven in money market funds, but we believe we have weathered the storm and we look forward to opportunities in the future.
Supporting economic recovery
One of the key challenges facing monetary policy makers is removing excess policy accommodation without derailing the U.S. economic recovery. Real GDP growth increased to about 4% in the third quarter of 2013, although expectations of growth slowed slightly in the fourth quarter. While current levels of growth continue to leave the economy susceptible to destabilizing forces, both foreign and domestic, economists remain confident that current levels of monetary policy accommodation will continue to support the recovery.
Market outlook
The foundation of our outlook is that monetary policy rates will remain anchored throughout the year 2014. Real GDP growth will likely average around 3%, in our view, and short-term U.S. Treasury note yields will likely rise modestly, with intermediate yields continuing to trade directionally with economic data. It remains possible that an unexpected improvement in economic conditions could shorten the current stance on policy accommodation and result in an increase in the term structure sooner than is currently anticipated by markets.
Conservative strategy
We continue to tactically manage portfolio duration, or interest-rate sensitivity, as measured in average days to maturity and are currently maintaining duration in the 40-day range, well within the statutory limit of 60 days. From a sector perspective, we maintain the conservative strategy of investing exclusively in government and U.S. agency securities, which we believe provide the most value on a risk-adjusted basis.

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.