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Real Return Fund —
The Fund’s U.S. real interest rate strategies drove outperformance in the first quarter
1st Quarter, 2017
"During the first quarter we moved to an underweight duration position overall. "
– Pacific Investment Management Company LLC

Much of the first quarter of 2017 was marked by surging optimism among U.S. businesses and consumers along with solid fundamentals that helped bolster risk appetites. However, the risk rally—spurred in part by expectations for growth enhancing policies such as fiscal stimulus, tax reform, and deregulation—moderated some as policy setbacks raised concerns about the administration’s ability to implement its pro-growth agenda.
During the first quarter, some post election trends continued: volatility remained relatively low, equities rallied, and credit spreads tightened. Others, though, moderated or reversed: U.S. yields were generally range-bound and a weaker Dollar helped emerging market assets recover their losses from the previous quarter.
The Bloomberg Barclays U.S. TIPS Index benchmark posted a return of 1.26% for the first quarter of 2017, faring better than the Bloomberg Barclays U.S. Aggregate Bond Index, a diversified benchmark of investment-grade bonds, which had a return of 0.82%. The Harbor Real Return Fund posted a return of 1.62% in the quarter, outperforming its TIPS benchmark.
The Fund invests primarily in inflation-linked bonds issued by the U.S. and other governments. During the first quarter, the Fund’s U.S. real interest rate strategies, including overweight positioning in U.S. breakevens, contributed to relative outperformance as U.S. inflation expectations continued their upward momentum. A modest out-of-index allocation to non-agency mortgage-backed securities also benefited relative return. Conversely, an underweight to U.K. nominal duration detracted, as rates fell in that country following a dovish Bank of England meeting in early February.
PIMCO’s comments were made in an April, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended March 31, 2017, unless otherwise indicated. All references to the year-to-date are for the period January 1 through March 31, 2017.

Interview Highlights

A Healthy Economic Backdrop
Solid U.S. economic data, relatively easy financial conditions and both business and consumer optimism gave the Federal Reserve (Fed) an opportunity to continue on its path toward policy normalization. The Fed’s March rate hike, though, was perceived as more dovish given the largely unchanged statement and “dot plot,” which shows where each member of the Federal Open Market Committee thinks the federal funds rate should be at the end of each of the next few years and in the longer term. Inflation expectations were generally stable despite fluctuations in oil prices related to building inventories in the U.S. and concerns over OPEC’s adherence to its production cut agreement.
The fundamental backdrop remained healthy and, relatively, unchanged. Supportive growth trends, including improving business activity indicators across developed and emerging regions, contributed to improved sentiment.
Change in Duration Positioning
PIMCO’s investment process and outlook focuses on longer term (three to five years) trends and secular considerations as political factors and structural changes in the domestic and international economy exert powerful, sustained influences on interest rates. Thus, a secular outlook updated annually determines a general maturity/duration range for the portfolio in relation to the market. During the first quarter we moved to an underweight duration position overall, favoring rate exposure in countries offering higher real yields.
We Anticipate Further Economic Expansion
We believe the nearly eight year old global economic expansion could strengthen and broaden over the coming year, driving global gross domestic product (GDP) growth to 2.75%–3.25% from 2.6% in 2016 and boosting consumer price index (CPI) inflation to 2.25%–2.75%. Our outlook reflects several factors that we consider encouraging, including an expectation of generally supportive fiscal policies in most developed market economies and easier financial conditions since the start of the year. In the U.S., we believe GDP growth could reach 2%–2.5% in 2017, should business investment recover and consumer spending improve. Our forecast anticipates that core inflation could hover sideways this year at 2.0%–2.5%, but we believe it likely that the Fed could feel encouraged by above-trend growth to raise interest rates two more times during 2017, on top of the March rate hike.

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