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Real Return Fund —
After sharp sell-off in 2013, a rebound for inflation-linked securities in Q1
1st Quarter, 2014
"Although the economy is improving, we're not expecting any substantial gains in inflation in the short-term. "
– Pacific Investment Management Company LLC

Following a down year in 2013, inflation-indexed bonds bounced back in the first quarter of 2014. The Barclays U.S. TIPS Index, which tracks the performance of U.S. Treasury Inflation-Protected Securities, returned 1.95% for the three months ended March 31, 2014. This followed a decline of -8.60% for the index for the 12 months ended December 31, 2013.
The Harbor Real Return Fund slightly outperformed the index with a return of 2.16% for the first quarter. 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).
The Fund had an emphasis on intermediate maturities in U.S. TIPS, where the yield curve was steepest, as well as exposure to Italian linked-inflation debt; both of these were positive for relative performance as yields rallied in both countries, the PIMCO team reports. An exposure to non-agency mortgage-backed securities also helped returns. These positive factors were offset in part by short positions in longer-dated nominal bonds in the U.S. and Japan, which benefited from declining rates.
PIMCO’s comments were made in an April 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2014.

Interview Highlights

Strong rebound
TIPS were among the hardest hit asset classes in 2013, down by almost 9%. This began last May when the Fed began to hint at tapering and TIPS sold off more sharply than nominal bonds. But TIPS rebounded strongly in Q1,with yields declining by about 19 basis points and posting a return of 1.95%, as measured by the Barclay’s U.S. TIPS Index. TIPS were supported by demand from global central banks and a deceleration of retail investor outflows.
Improving growth outlook
We expect real GDP growth in the U.S. of about 2.5% to 3%. Fiscal drag has been diminishing and we would expect the fiscal side to be much less of a headwind and potentially more of a tailwind going forward. We are seeing some improvement in the employment situation and we believe that the strong performance of the stock market is likely to create a wealth effect along with improved consumer sentiment. We've effectively moved our economic forecast closer to the consensus view, with the possibility of a slight pick-up from here as consumer and corporate balance sheets continue to improve and credit conditions ease.
Benign inflation outlook
Although the economy is improving, we’re not expecting any substantial gains in inflation in the short-term. As a result, we think the middle part of the yield curve continues to be the most attractive for TIPS investors. Our duration positioning is close to neutral but slightly underweight the benchmark.
Overseas exposures
We continue to be long in German and Italian inflation-linked bonds. We like both of those on the basis of attractive real yields in comparison with U.S. markets. We also have a 2.5% position in Brazil, which continues to be one of our stronger-conviction emerging market areas. It is an unusually high-rate market and thus a source of incremental yield for the portfolio.

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.