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Real Return Fund —
Inflation-indexed bonds registered positive returns to close out 2011
4th Quarter, 2011
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"We have diversified away from the low real yields we're getting in the U.S. market. "
– PIMCO Investment Strategy Group

Inflation-linked bonds moved modestly higher in the fourth quarter amid continuing uncertainty over Europe's debt crisis and its potential impact on the global economy. Inflation-indexed securities, as measured by the Barclays Capital U.S. TIPS Index, returned 2.69% for the three months ended December 31, 2011.
The Harbor Real Return Fund slightly lagged the index with a return of 2.53% for the quarter. The Fund is managed by Mihir Worah, an executive vice president of Pacific Investment Management Company (PIMCO).
Treasury inflation-protected securities, or TIPS, outperformed their nominal Treasury counterparts in the quarter as inflation expectations increased, PIMCO reports. Bonds of financial institutions, emerging markets securities, and positions in Australian and Canadian inflation-linked bonds were among the portfolio positions adding value for the Fund, PIMCO says. Detractors included investments in non-agency mortgage-backed securities and a lower-than-index exposure to U.S. TIPS.
PIMCO's comments were made in a January 18, 2012, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2011, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2011.

Interview Highlights

Global exposure to real yields
We have more emphasis on real yields in places like Canada and Australia, in addition to the U.S. We have diversified away from the low real yields we're getting in the U.S. market. It gives us a higher starting yield as well as the potential for future price increases as real yields compress in these non-U.S. markets. That's why we like having the ability to buy global TIPS across many markets.
Diversification benefit
The attractiveness of TIPS comes from the diversification they offer and also the ability for real yields to compress even more. The expectation of declining inflation is typically bad for inflation-linked bonds. But if we have a disorderly outcome in Europe, which we think is likely, TIPS and nominal bonds could both do very well relative to riskier assets.
Anemic U.S. growth
As we move forward, we think economic growth in the U.S. will be positive but anemic. We think the U.S. will grow between 0% and 1%, despite some recent positive data. That is probably all we can expect because most of the positive data have come from seasonal factors, not organic demand. We see the ability to increase fiscal spending as very limited given already high government deficits and the fact that it's an election year in the U.S.
Stronger balance sheets
We think U.S. corporations have better balance sheets in general than their European counterparts. The deleveraging that has happened in the corporate sector in the U.S. is just beginning in euro land, so we think U.S. companies have lower default risk and certainly would be less impacted by a disorderly outcome in Europe.

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.