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Commodity Real Return Strategy Fund —
Commodities down for the year after sharp decline in Q3
3rd Quarter, 2014
"It is entirely reasonable to expect continued weakness in commodity markets, especially in energy, in the near-term, as we work through this slower patch in the economic cycle. On a long-term basis, however, we believe there is every reason to be constructive on the commodities market. "
– Pacific Investment Management Company LLC

Commodity prices experienced a steep decline in the third quarter of 2014, pushing returns into negative territory for the year. The Bloomberg Commodity Index Total ReturnSM, an unmanaged index of futures contracts on a diversified group of physical commodities, registered returns of -11.83% for the quarter and -5.59% for the nine months ended September 30, 2014. The third quarter decline occurred amid a strengthening U.S. Dollar and investor concerns over the pace of global economic growth.
The Harbor Commodity Real Return Strategy Fund returned -13.53% for the quarter, lagging the index. On a year-to-date basis, the Fund outperformed the Bloomberg Commodity Index Total ReturnSM benchmark with a return of -4.92% for the first nine months. The Fund also 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. The Fund is managed by Mihir Worah of Pacific Investment Management Company (PIMCO).
In the third quarter, active management of the Fund's commodity exposure contributed positively to performance relative to the index, the PIMCO team reports. This included strategies designed to benefit from weakening oil, wheat, and sugar pricing. Currency positioning also helped performance as the U.S. Dollar gained strength relative to the Euro and Japanese Yen. Management of the collateral portfolio detracted from performance, PIMCO notes, as an emphasis on the intermediate-maturity part of the TIPS yield curve hurt relative returns. Outside the U.S. TIPS market, inflation-linked bonds in Italy and the UK benefited the portfolio, as did a small position in non-agency mortgage-backed securities.
PIMCO's comments were made in an October 15, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended September 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through September 30, 2014.

Interview Highlights


Global weakness
Commodities struggled during the third quarter, given U.S. Dollar strength, weaker global economic conditions, and a slowdown in the commodity-intensive Chinese economy. Agriculture was one of the weakest performers as we saw record harvests of U.S. and northern hemisphere row crops. An oversupplied crude oil market along with weak demand prompted negative returns in the energy sector. Metals declined slightly as weakness in Chinese growth led to decreased demand expectations for metals, and a stronger Dollar and improved economic outlook prompted a decline in gold prices.
Constructive outlook
It is entirely reasonable to expect continued weakness in commodity markets, especially in energy, in the near-term, as we work through this slower patch in the economic cycle. On a long-term basis, however, we believe there is every reason to be constructive on the commodities market. Demand is there, and as the global economy regains strength we would expect to see further increases in demand from both developed and emerging market countries.
Agriculture strategies
In terms of agriculture positioning, we are short in the soy bean sector and long corn. This is driven by the fact that the price differential between soy beans and corn has moved into a territory that we believe is not sustainable. Our view is that higher levels of soy bean pricing will attract increased production in that segment, and that as a result corn and soy bean prices will converge over time, closer to their historical levels.
Natural gas pricing
We think the risk premium for natural gas that is associated with the winter consumption period will subside as we move toward the winter months. Our view is that the market will recognize that there is a substantial amount of inventory out there and that there will be more than enough natural gas available.

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.