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High-Yield Bond Fund —
High yield feels the effects of global economic uncertainty
4th Quarter, 2015
"The risk-off trade that started in mid-2014 continued with a vengeance during the fourth quarter of 2015. "
– Shenkman Capital Management, Inc.

High yield bonds generated a loss of -2.17% for the fourth quarter of 2015, according to the BofA Merrill Lynch US High Yield Index, against a backdrop of tremendous uncertainty about both the impact of China’s slowdown on the global economy and the frequency of anticipated interest rate increases by the U.S. Federal Reserve.
Losses for the Harbor High-Yield Bond Fund and its benchmark, the BofA Merrill Lynch US Non-Distressed High Yield Index, during the fourth quarter were concentrated in a few sectors. The Fund had a negative return of -1.77%, and the benchmark’s return was -0.33%. According to Portfolio Manager Eric Dobbin, the oil and gas industries were hit the hardest as these areas continued to be pressured due to slowing global growth. The Fund was slightly underweight in banking, which proved to be a disadvantage relative to the benchmark. On the positive side, the Fund’s overweight in cable and positive selection and overweight in broadcasting contributed during the period.
The impact of oil pricing on the market was a significant depressant throughout 2015. Heading into 2016, the Manager believes the markets may feel further effects from election year uncertainty. On the positive side, the Manager is seeing a large uptick in spending for broadcasting. There is a liquidity gap in the marketplace, driven by the Energy sector meltdown, and a lack of bids from buyers of high yield debt for Energy bonds as of yet. This illiquidity has been further exacerbated by an increase in the sales of exchange-traded funds (ETFs) to sell credit risk aggressively. The bifurcation between oil and gas on the one hand and the rest of the market on the other took a toll on lower rated debt securities during the period. Fears of an uptick in defaults persist.
Eric Dobbin’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 the year-to-date are for the period January 1, 2015, through December 31, 2015.

Interview Highlights

Sector Positioning
The Fund’s performance was negatively impacted by some selections in oil and gas, as well an underweight position in banking, which is traditionally a small segment for the Fund. However, the Fund’s overweight in cable and positive selection and overweight in broadcasting was a positive contributor. Against the broader market, the Fund ended the quarter underweight in oil and gas, with an ending weight of 4.85%, while the broader market's ending weight was 7.48%.
Reducing Risk
The risk-off trade that started in mid-2014 continued with a vengeance in the fourth quarter of 2015 in the broader market. As a result, we did not simply trim our positions in oil and gas during the period; there was a broader reduction of risk in the Fund. The Fund’s conservative strategy dictated a migration toward higher quality credit. As some of the riskier bonds have decayed, we sold the Fund’s weakest names to improve and preserve credit quality. In the commodities space, the Fund carries little risk in the non-steel metals and mining group, and steel exposure is quite low. We have reduced risk in the chemicals space as we believe that the possibility of a slowing Chinese economy and a weak economy in Brazil could impact the chemicals industry. There is tremendous uncertainty at the moment as to the impact of China on the global economy as a whole.
The high yield market is currently in an interesting position—it is getting paid significantly more than long-term averages. Generally in this type of situation, one of two things could occur: either there is a recession, which is not what we expect, or there will be tightening and success in the high yield marketplace overall. We believe that defaults will be trending higher, driven primarily by highly visible oil and gas, coal, and commodities names. However, we do not believe that we are likely to be facing a widespread, systemic increase in defaults, as leverage has actually remained in check and issuance has dropped off significantly over the last few months.

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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.