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Real Return Fund —
Inflation-linked bonds record positive return for Q1
1st Quarter, 2015
"We expect that inflation will continue to be subdued in 2015, aided by the effects of low oil prices. Over a longer period, however, we believe that inflation will start rising as quantitative easing programs and other accommodative measures start to gain traction in supporting economic growth. "
– Pacific Investment Management Company LLC

U.S. inflation-linked bonds posted a return of 1.42% for the first quarter of 2015, as measured by the Barclays U.S. TIPS Index. The index tracks the performance of U.S. Treasury Inflation-Protected Securities. By comparison, investment-grade bonds returned 1.61% for the quarter, as measured by the Barclays U.S. Aggregate Bond Index.
The Harbor Real Return Fund returned 1.58% for the quarter, slightly outperforming the index. The Fund invests primarily in inflation-indexed bonds issued by the U.S. and other governments. It is managed by Mihir Worah and Jeremie Banet of Pacific Investment Management Company (PIMCO).
An emphasis on the intermediate part of the TIPS yield curve versus longer maturities aided relative performance, the PIMCO team reports, as the curve steepened during the quarter. Exposure to Italian, Australian, and New Zealand inflation-linked bonds, as well as Spanish nominal bonds, also helped returns, as did currency strategies based on a stronger U.S. Dollar. Tactical positions in Mexican inflation-indexed bonds detracted from performance, as they came under selling pressure after rallying in the prior quarter.
PIMCO’s comments were made in an April 14, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2015, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2015.

Interview Highlights


Global markets
Global inflation-linked markets saw positive returns over the first quarter, with real rates benefiting from central bank easing. Real yields rallied most notably in January, as the European Central Bank announced a quantitative easing program and other global central banks implemented rate cuts. Breakeven inflation levels rose across most global inflation-linked bond markets amid generally stronger inflation data and possible signs of oil market stability.
January gains
U.S. TIPS had positive performance for the quarter, driven by a decline in real yields across maturities. Gains primarily occurred in January, as real yields were supported by weak economic data and dovish Fed statements. The following two months, however, saw positive economic headlines. We saw a strong employment report, and real yields were pushed higher, causing TIPS to lose some of their previous gains.
Inflation outlook
We expect that inflation will continue to be subdued in 2015, aided by the effects of low oil prices. Over a longer period, however, we believe that inflation will start rising as quantitative easing programs and other accommodative measures start to gain traction in supporting economic growth. The Federal Reserve is targeting a 2% inflation rate over a longer period of time, and we would expect the Fed to continue to work toward that long-term goal.
Portfolio positioning
We are underweight duration versus the benchmark in a range of about six to nine months, and we are favoring the middle part of the yield curve. We are tactically long in Italian and Spanish inflation-linked bonds. We hold some German bonds and we have some New Zealand exposure as well. We also like Mexico, given that we believe its economic growth prospects are strong.
Tracking valuations
One of the drivers in terms of the attractiveness of TIPS is not only whether we expect inflation to rise but also the relative attractiveness of their valuations compared to nominal bonds. Pricing is perhaps slightly less attractive than it was at the end of last quarter, but TIPS are still attractive in our view.

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 www.harborfunds.com.

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.