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Commodity Real Return Strategy Fund —
Commodities fall amid declining energy prices, global growth concerns
4th Quarter, 2014
"While the U.S. has posted strong growth in employment numbers, European and Japanese markets continued to struggle to emerge from a weaker growth trend. This divergence has created a period of U.S. Dollar strength, which further weighed on commodity markets. "
– Pacific Investment Management Company LLC

Downward pressure on commodity prices continued in the fourth quarter of 2014, as the Bloomberg Commodity Index Total ReturnSM posted a return of -12.10%. The decline, following a third quarter drop of 11.83%, took place against a backdrop of falling energy prices, a strengthening U.S. Dollar, generally low inflation, and worries over weak global growth. For the 12 months ended December 31, 2014, the index returned -17.01%. The Bloomberg Commodity benchmark is an unmanaged index of futures contracts on a diversified group of physical commodities.
The Harbor Commodity Real Return Strategy Fund returned -14.43% for the fourth quarter and -18.63% for the full year, lagging the index. Longer term, the Fund outperformed the index for the latest five-year period 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. It is managed by Mihir Worah, Nicholas Johnson, and Jeremie Banet of Pacific Investment Management Company (PIMCO).
Management of the collateral portfolio detracted from performance relative to the index in the fourth quarter, the PIMCO team reports. As oil prices declined, inflation expectations followed suit, leading to underperformance by TIPS relative to nominal Treasury securities. In terms of the Fund's commodity exposure, positions in crude oil, natural gas, and corn benefited returns, while a decline in ethanol prices hurt relative performance.
PIMCO’s comments were made in a January 14, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2014.

Interview Highlights

Stronger dollar
Commodities continued to struggle in the fourth quarter as the steep drop in oil prices pervaded most markets. While the U.S. has posted strong growth in employment numbers, European and Japanese markets continued to struggle to emerge from a weaker growth trend. This divergence has created a period of U.S. Dollar strength, which further weighed on commodity markets.
Pressure on oil
Oil was the primary driver of negative returns during the quarter as the Energy sector posted losses of nearly 40%, led by crude oil and natural gas. OPEC's decision in late September to preserve market share sent oil into a tailspin and supply-side pressure was reaffirmed at its Thanksgiving Day meeting, when members did nothing to support prices. Natural gas prices also declined as strong production coincided with a warmer winter.
Concerns on global growth
Metals posted negative returns over the quarter, as precious metals were weighed down by a stronger Dollar, given the end of quantitative easing and the potential for rate increases occurring in 2015. Base metals also posted losses, reflecting global growth concerns, particularly in emerging markets.
Agriculture sector up
Agriculture was a bright spot in commodities as prices increased. Weather concerns, ranging from Brazil to Russia, supported prices in agricultural products, including wheat, coffee, and sugar. Corn was supported by constructive U.S. export reports.
Demand for gasoline
We have a long position on gasoline versus Brent crude. This is based on an expectation that falling oil prices will result in increased demand for gasoline here in the United States in particular. Cheaper oil usually results in individuals buying larger cars and driving more, so we expect that gasoline production will increase as a result of demand.

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