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Unconstrained Bond Fund —
Defensive strategies reflect conservative economic outlook for 2012
4th Quarter, 2011
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"The outlook is particularly weak in Europe, where we expect a recession of 1% to 1.5% over the course of 2012. "
– PIMCO Investment Strategy Group

The Harbor Unconstrained Bond Fund registered returns of 0.47% for the fourth quarter and 1.32% for the 12 months ended December 31, 2011. By comparison, the BofA Merrill Lynch US Dollar 3-Month LIBOR Constant Maturity Index returned 0.07% for the quarter and 0.27% for the full year. The Harbor Unconstrained Bond Fund is managed by Chris Dialynas, a managing director of Pacific Investment Management Company (PIMCO).
A number of strategies contributed to Fund performance in the fourth quarter, PIMCO reports. These included exposure to non-U.S. government debt, emerging markets investments in Brazil and Mexico, corporate securities in the Financials and Industrials sectors, and modest investments in municipal bonds and inflation-linked bonds. A duration hedging strategy, implemented primarily through interest rate swaps in core Europe and Japan, detracted from performance.
Looking ahead, the PIMCO team expects positive but anemic economic growth in the U.S., a slowing rate of growth in China, and a possible recession in Europe in 2012. Consequently, portfolio strategies reflect a focus on sources of low-risk incremental yield versus like-duration U.S. Treasurys.
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

Slower growth for China
As we look around the world for growth, we do see higher growth in the emerging world, particularly in China. We don't expect China to be immune from the slowing growth rates of its major developed market customers. So to the extent that we see China's growth rates slowing, we're thinking it will slow to about 7%.
Duration strategy
We will probably be in the two-to-three-year duration area to start, with the idea being that is where we will get the maximum yield from the steepest part of the yield curve relative to volatility. What that implies is that we think there is a sweet spot of yield per unit of volatility. The Fund can get much more defensive or much more aggressive depending on what happens in the market, but that's where we'll probably start the quarter.
Weak outlook for Europe
The outlook is particularly weak in Europe, where we expect a recession of 1% to 1.5% over the course of 2012. Despite significant moves by the European Central Bank to help boost liquidity in the eurozone, we think there is a meaningful risk to the sovereign nations that are deeply in debt. Some of this has already been priced in but liquidity risks can increase, meaning that the liquidity premium can also increase.
Strong fundamentals
Looking at corporate bonds, we think U.S. companies in the Financials sector have very strong fundamentals. Their creditworthiness continues to improve and we think they're well positioned to recover from their underperformance in 2011.

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.