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Real Return Fund —
Performance of inflation-linked bonds generally mirrored that of the bond market in Q4
4th Quarter, 2015
"TIPS outpaced nominal Treasuries for the quarter as breakeven inflation levels recovered, despite the oil market headwinds we saw. "
– Pacific Investment Management Company LLC

Global inflation-linked bonds performed in line with comparable nominal sovereigns during the fourth quarter of 2015. However, performance was volatile as strong outperformance at the start of the quarter was later negated as sliding oil prices pressured global breakeven inflation levels in December. The Barclays U.S. TIPS Index posted a negative return of -0.64% for the quarter, a very similar return to that of the Barclays U.S. Aggregate Bond Index, a diversified benchmark of investment grade bonds, which declined -0.57%. The Harbor Real Return Fund fell -0.59% in the quarter, performing slightly better than the Treasury Inflation-Protected Securities (TIPS) index. The Fund invests primarily in inflation-linked bonds issued by the U.S. and other governments.
The Fund held an overweight position in longer term TIPS, which proved detrimental to performance as real interest rates rose over the period. Smaller positions, including exposure to Mexican inflation-linked bonds and a short position in U.K. inflation-linked securities also hurt relative returns in the quarter. On the plus side, the Fund benefited from exposure to Italian inflation-linked bonds. Currency positioning was also a relative contributor for the Fund during the quarter.
PIMCO’s comments were made in a January 15, 2015 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

Catalysts for Increased Inflation Expectations
We would expect that at some point, the wage pressures will start to actually bubble up in the economy. We have not seen that as of yet, but if you look at the unemployment figures, for example, those have continued to come down, and we're back at levels that used to be considered normal. That being said, obviously there are questions about whether labor market participation is being accurately reflected. But I think an improved employment picture is usually the key driver in an economic expansion in terms of what starts inflationary pressures. Now, we also have countervailing forces right at this moment, which is the oil price, and also the possible slowdown in China. Both of those are potentially deflationary to the world.
Portfolio Positioning
If you look at the positioning of the Fund, we're modestly underweight duration against the benchmark. We take exposure in the steepest part of the curve, which is usually the five to seven year part in the real return markets. And we do like some of the bonds in the long end, because of the higher real yield that they're providing. We also own some intermediate and long-dated inflation-linked bonds. It's not large in the context of the portfolio but it provides enhanced yields for the investments that we have in place. We lessened our exposure to Italian inflation-linked bonds slightly.
Currency Positioning Held Steady
Lastly, I'll mention the long Dollar bias. That's a position where we believe the divergence in monetary policies between countries could provide support; and we're underweight the Euro a modest amount. In addition, we maintained short positions on a basket of Asian currencies—the Singapore Dollar, Korean Won and Taiwanese Dollar—expecting that the U.S. Dollar may continue to strengthen.

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