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High-Yield Bond Fund —
High yield market extends prior year gains with further advance to start 2013
1st Quarter, 2013
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"Credit conditions within the high yield market remain benign as the default rate continues to hover at approximately 1.4%. This is significantly below the historical average of approximately 3.9%. "
– Mark Flanagan

Adding to double-digit gains last year, high yield bonds moved higher in the first quarter of 2013. The BofA Merrill Lynch U.S. High Yield Index generated a return of 2.85% for the three months ended March 31. This followed a return of 15.59% for calendar 2012.
Mark Flanagan, Portfolio Manager of the Harbor High-Yield Bond Fund, notes that a risk-on strategy appeared to dominate investor sentiment in the first quarter, with U.S. equities recording double-digit gains. In this environment, high yield bonds clearly outperformed other fixed income sectors such as U.S. government securities and investment grade corporates, Flanagan reports. High yield securities remained a popular source of financing as first quarter new issuance totaled $119 billion, topping a strong first quarter in 2012, he adds.
Looking ahead, Flanagan believes that the possibility of rising interest rates should not represent a serious near-term threat, given persistently slow economic growth. He also believes that default rates in the high yield market are likely to remain well below their historical average in the months ahead. Under these conditions Flanagan sees the high yield sector as a viable choice for investors seeking additional yield.
In the first quarter the Harbor High-Yield Bond Fund returned 1.73%. Flanagan reports that the performance differential between the Fund and the index was due primarily to a portfolio underweight to lower-quality bonds, which outpaced the overall high yield market during the quarter, and a larger than benchmark allocation to the cable media sector, which lagged the market.
Mark Flanagan's comments were made in an April 16, 2013, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2013, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2013.

Interview Highlights

Persistently sluggish growth
One theme that continues to dominate investor sentiment is that economic growth may be chronically slow for many years. The Congressional Budget Office recently forecast that real GDP will be in a range of 1.8% to 2.5% through 2023. If this forecast is accurate, that would be 10 years of subpar growth despite the unprecedented stimulus that has been allocated to the U.S. economy since the downturn of 2008. We believe this should make it clear that investors need to resign themselves to an environment of persistently low growth for an extended period of time.
Low default rates
Credit conditions within the high yield market remain benign as the default rate continues to hover at approximately 1.4%. This is significantly below the historical average of approximately 3.9%. We would expect the default rate to remain near its current level for the balance of the year based on the strong credit fundamentals and strong balance sheets that many high yield issuers now have.
Bank loan exposure
We believe certain bank loans look relatively more attractive than they did for much of 2012 as bond yields have compressed to levels similar to loan yields. To the extent that we can continue to source loans with yields comparable to our bond holdings, we would expect to maintain a bank loan weighting of 6% to 9% in the portfolio.
Targeting new issues
In the first quarter, the Fund was an active participant in the primary market, taking part in 28 new high yield issues across 14 industry sectors. We continue to believe that the new issue market is the most attractive way to create investment opportunities that have capital appreciation potential to augment the record low yields that are currently available in the high yield market.
Attractive source of yield
We believe the next correction in the high yield market is most likely to be as a result of rising interest rates and not because of any significant credit deterioration. Historically, interest rate driven corrections have had a much milder impact on the high yield market than credit deterioration corrections. Moreover, at least for the balance of this year, we do not anticipate any significant rise in interest rates or in defaults and therefore continue to view the high yield space as an attractive asset class for investors seeking incremental yield.

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.