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Real Return Fund —
Harbor Real Return Fund outpaces index as inflation-linked bonds move higher in Q2
2nd Quarter, 2014
"We are positioning somewhere in the middle part of the yield curve, where the slope is steepest, while at the same time staying fairly close to benchmark duration in anticipation of potentially rising rates overall. "
– Pacific Investment Management Company LLC

The Harbor Real Return Fund recorded returns of 4.25% for the second quarter of 2014 and 6.50% for the six months ended June 30, 2014, outpacing its benchmark, the Barclays U.S. TIPS Index, for both periods. The index, which tracks the performance of U.S. Treasury Inflation-Protected Securities, returned 3.81% for the second quarter and 5.83% for the first half of 2014. The Fund also outperformed the index for the 12-month and 5-year periods ended June 30, 2014.
The Fund invests primarily in inflation-indexed bonds issued by the U.S. and other governments. It is managed by Mihir Worah, executive vice president and managing director of Pacific Investment Management Company (PIMCO).
In the second quarter, a focus on intermediate maturities of U.S. inflation-indexed bonds was a positive contributor to performance for the Fund, as were tactical exposures to debt in Australia, Italy, and Spain, the PIMCO team reports. At the same time, an underweighted exposure to the long end of the nominal U.S. Treasury yield curve detracted from performance, as did an underweight to Japanese nominal duration.
Continued investor demand and an uptick in energy and other costs helped drive TIPS prices higher in the second quarter, the PIMCO team says. Looking ahead, PIMCO expects moderately higher inflation, with the Federal Reserve taking action if necessary to keep it from rising much above the 2% level.
PIMCO’s comments were made in a July 14, 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


Portfolio positioning
In terms of positioning, we are targeting neutral duration versus the benchmark. We are positioning somewhere in the middle part of the yield curve, where the slope is steepest, while at the same time staying fairly close to benchmark duration in anticipation of potentially rising rates overall. We have been adding a little bit to the long end of the curve, which is a change from last quarter.
Higher energy prices
In general, TIPS returns were underpinned by supportive inflationary data as well as continued investor demand. TIPS outperformed like-duration nominal Treasurys, as break-even inflation levels widened across the yield curve, given that reported inflation exceeded market expectations. This was driven predominantly by increases in energy prices as well as higher costs of shelter, food, beverages, and apparel.
Slightly higher inflation
We believe that inflation will likely increase in 2014. The PCE (Personal Consumption Expenditures price index) here in the United States has been around 1% and we currently expect longer-run inflation to be closer to 2%. At the same time, we expect that the Federal Reserve and other central banks will keep inflation in a reasonably tight range. We don’t expect it to rise much above the 2% number.
European bonds
We like German and Italian inflation-linked bonds. Both countries currently have break-even rates well below 1%, meaning that markets are pricing in an expectation of less than 1% inflation in the euro area. We don’t think that will be the case on a longer-term basis. Obviously there is some concern about deflation in Europe but I think central banks also are highly attuned to the risk of deflation and would be likely to fight effectively against it. Thus we believe that these bonds could represent a nice opportunity.

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.