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Commodity Real Return Strategy Fund —
Commodities conclude 2013 with Q4 decline
4th Quarter, 2013
"In the United States we expect growth between 2.25% and 2.75% for the year ahead. "
– PIMCO Investment Strategy Group

Commodity prices slid lower in the fourth quarter of 2013 and posted a negative return for the full year. The Dow Jones-UBS Commodity Index, an unmanaged index of futures contracts on a diversified group of physical commodities, returned -1.05% for the three months ended December 31, 2013, and -9.52% for the calendar year.
The Harbor Commodity Real Return Strategy Fund trailed the index with returns of -2.42% for the quarter and -14.93% for the year. From a longer-term perspective, the Fund outperformed the index for the five years ended December 31 and since its inception in 2008. The Fund invests in commodity-linked derivative instruments backed by a portfolio of inflation-indexed bonds such as Treasury Inflation-Protected Securities (TIPS) and other fixed income securities. The Fund is managed by Mihir Worah, a managing director and portfolio manager of Pacific Investment Management Company (PIMCO).
Among commodities, energy prices advanced during the fourth quarter while the agriculture and precious metals sectors retreated, the PIMCO team reports. The use of TIPS in the collateral portfolio hurt the Fund's performance relative to the index, PIMCO reports, as did exposure to bonds in Australia and Brazil. The Fund continued to hold a small allocation to non-agency mortgage-backed securities, which was positive for relative performance.
PIMCO's comments were made in a January 16, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2013, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2013.

Interview Highlights

Precious metals down
Precious metals sold off during the fourth quarter, especially gold and silver. They have struggled under pressure from a strong U.S. Dollar and improving economic data in the U.S. The sector posted a decline of -9.8% for the quarter.
Fed tapering
In the United States we expect growth between 2.25% and 2.75% for the year ahead. We've already seen the Federal Reserve's decision to begin reducing its purchases of mortgage-backed securities as well as Treasurys, as a result of improving financial conditions.
Portfolio positioning
We are maintaining a neutral duration in the TIPS portfolio. We have some out-of-benchmark allocations such as Australian and European inflation-linked bonds for diversification, but predominantly our exposure is coming from the U.S. TIPS market.
Soft TIPS market
The vast majority of underperformance in 2013 came from the TIPS collateral. The yield of the 10-year U.S. TIPS, for example, increased by 151 basis points [1.51 percentage point] over the year, which is a pretty dramatic rise in interest rates. That was the key driver when you look at the Fund's performance against the Dow Jones-UBS benchmark.
Potential for rising rates
If there is a rising-rate environment here in the United States in the future, we believe it will manifest itself as a steepening of the yield curve. The unemployment rate is still too high and the inflation rate too low, in our view, for the Federal Reserve to truly start tightening monetary conditions by increasing the federal funds rate.

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.