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Real Return Fund —
Markets remained resilient in the third quarter
3rd Quarter, 2016
"A soft patch in U.S. growth in the first half of 2016 was tempered by continued improvement in labor market gains and U.S. consumer spending. "
– Pacific Investment Management Company LLC

Markets generally shook off the surprise Brexit result as equities rallied and volatility remained low despite building concerns over the future path of monetary policy globally. Markets remained relatively resilient despite a host of geopolitical shocks, including new leadership in the United Kingdom and Brazil, an attempted coup in Turkey and an increasingly contentious presidential race in the United States. Volatility generally remained below long-term averages, U.S. equities set new all time highs, credit spreads tightened and emerging market assets performed well in the seemingly benign market environment.
The Barclays U.S. TIPS Index posted a positive return of 0.97% for the third quarter of 2016, outgaining the Barclays U.S. Aggregate Bond Index, a diversified benchmark of investment-grade bonds, which gained 0.46%. The Harbor Real Return Fund advanced 1.49% in the quarter, outpacing its TIPS benchmark.
The Fund invests primarily in inflation-linked bonds issued by the U.S. and other governments. During the quarter, the Fund’s interest rates strategy, with an underweight to nominal rates in favor of real rates, contributed to relative return as U.S. rates drifted higher. The Fund’s global relative value strategies detracted from relative return as U.K. breakeven inflation rates widened over the quarter on the back of continued weakness in the Pound and further easing efforts from the Bank of England.
PIMCO’s comments were made in an October, 2016 report. Highlights adapted from the report appear below. All comments relate to the quarter ended September 30, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through September 30, 2016.

Interview Highlights


Economic Backdrop
Central banks held the spotlight as concerns over the longevity of central bank support grew amidst the uneasy market calm. The Bank of Japan’s “comprehensive review” led to a shift in framework from base-money targeting to yield curve targeting with an intent to steepen the curve, which was welcome news to Japanese banking and insurance stocks that had been under pressure from negative interest rate policy. A largely unchanged and tepid fundamental backdrop did little to dampen risk sentiment. A soft patch in U.S. growth in the first half of 2016 was tempered by continued improvement in labor market gains and U.S. consumer spending. In Europe, both the U.K. and eurozone showed signs of resiliency post-Brexit as business and consumer sentiment rebounded after initial data suggested a darker outlook.
Positioning
We remain overweight breakevens in the U.S. given that investor expectations embedded in markets still appear too depressed in light of the Fed’s efforts to reflate the economy. Within the TIPS segment of the portfolio, we remain tactical in terms of curve positioning based on relative value and roll-down opportunities. We also look to seek out relative value opportunities across countries and yield curve structures as well as between real and nominal rates.
Outlook
PIMCO’s investment process and outlook focuses on longer term (three to five year) 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. Short-term, cyclical economic considerations determine shifts within this range. During the third quarter, we did not substantially change our outlook. We continue to expect the “delicate handoff” from slowing job growth to higher wages to succeed as the main driver of income creation, supporting further gains in consumer spending, and we do not expect a global or U.S. recession over the cyclical horizon.

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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.