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High-Yield Bond Fund —
High yield market extends gains in Q2
2nd Quarter, 2014
"This type of environment, in our view, is one that could reward skills in individual security selection, rather than favoring macro plays trying to take advantage of a big trend move, upwards or downwards, in rates. "
– Shenkman Capital Management, Inc.

Building on a solid performance in the first quarter, high yield bonds gained further ground in the three months ended June 30, 2014. Debt instruments issued by lower-rated U.S. companies recorded returns of 2.57% for the second quarter of 2014 and 5.64% for the first half of the year, as measured by the BofA Merrill Lynch US High Yield Index.
Although high yield returns through the first six months of 2014 exceeded expectations of many observers, the overall environment for speculative-grade bonds remains favorable, in the view of Eric Dobbin, Portfolio Manager of the Harbor High-Yield Bond Fund. He cites continued strong earnings performance and solid balance sheets for high yield issuers, reasonable valuations, and a favorable default environment.
The Harbor High-Yield Bond Fund returned 2.02% for the second quarter of 2014 and 4.99% for the first half. Dobbin reports that portfolio holdings in the Media & Cable industry helped Fund performance relative to the BofA Merrill Lynch US High Yield Index benchmark, while bonds in the Banking and Utilities segments underperformed those in the index.
Looking at the possibility of rising interest rates in a gradually improving economy, the investment team is holding the Fund's duration below that of the index while increasing its exposure to floating-rate debt, Dobbin says. The team also is focused on higher quality credits within the high yield universe. From an industry perspective, the Fund has above-index exposures to the Oil & Gas and Media & Cable segments, while maintaining underweights in Telecommunications and Finance.
Eric Dobbin's comments were made in a July 15, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended June 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through June 30, 2014.

Interview Highlights

Positive outlook for high yield
We think the macro view on high yield remains very supportive. The fundamentals, technical factors, and relative value in the market all remain fairly positive. Fundamentally, companies are hitting their earnings. That means the balance sheets are solid, cash flows are solid. From a technical perspective, fund flows have remained fairly good. We also have seen a decline in issuance as the vast majority of refinancing has taken place. Generally that makes for a good technical picture. As for relative values, yield spreads relative to investment-grade bonds have remained at historical averages. Spreads to U.S. Treasurys are somewhat inside the historical averages but they are not at a point where markets have faced great difficulty in the past. In addition, we continue to have a benign default environment, which supports the ability of the market to rally.
Upside surprise
One surprising development in the first half was just how well the high yield market performed. I think if you could rewind to the start of the year, many people would have been happy with full-year performance in high yield of 5% to 6%. Instead, we've already hit the 5.5% mark.
Security selection
We expect generally sideways movement in interest rates going forward. We have seen it in high yield over the last couple of months and we think it will continue over the rest of the year. This type of environment, in our view, is one that could reward skills in individual security selection, rather than favoring macro plays trying to take advantage of a big trend move, upwards or downwards, in rates.
Controlling duration
When we think about risks in the marketplace, one is that interest rates move up, and if you've got a longer duration, you're going to get impacted more significantly. The duration of the portfolio is currently running at about 3.1 years versus the index, which is running at 3.6 years. So we've managed to keep the duration in check.
Opting for stronger credits
Right now in high yield, the yield spread between the strongest credits at 4.75% to 5% and the weakest credits at 6% to 6.25% is only about 150 basis points. So where we have a choice we are opting to stay invested in stronger credits and stronger bonds within capital structures, because the potential for added return may not fully compensate you for the higher risk. That is another way in which we are trying to protect the portfolio.

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

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.