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Unconstrained Bond Fund —
Despite Q4 decline, Unconstrained Bond Fund manages flat return for 2013
4th Quarter, 2013
"The Fund has a focus on the front end of the curve while being underweight at the long end, where we think there is more uncertainty. "
– PIMCO Investment Strategy Group

Investment-grade bonds, as measured by the Barclays U.S. Aggregate Bond Index, posted a slight decline in the fourth quarter of 2013 as well as a negative return for the full year. The index, a measure of the broad taxable U.S. bond market, returned -0.14% for the three months ended December 31, 2013, and -2.03% for the calendar year. The BofA Merrill Lynch US Dollar 3-Month LIBOR Constant Maturity Index recorded positive returns of 0.06% for the quarter and 0.29% for the full year.
In this environment, the Harbor Unconstrained Bond Fund posted a negative return of -0.68% for the fourth quarter and a flat return of 0.00% for the calendar year. The Fund is managed by Bill Gross, a managing director of Pacific Investment Management Company (PIMCO).
Overall interest rate strategies detracted from returns in the fourth quarter as rates rose across the yield curve, the PIMCO team reports. Investments in bonds from emerging economies and investment strategies targeting investment grade and high yield securities also weighed on performance in the quarter. These negative factors were offset partially by positions in both U.S. agency and non-agency mortgage-backed bonds.
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

Portfolio positioning
With improving economic data as a backdrop, the Federal Reserve announced its intention to begin reducing its bond purchases from $85 billion a month to $75 billion. At the same time, however, the Fed provided forward guidance with respect to the policy rate, affirming that it will remain near the zero until signs of sustainable growth become more broadly evident. This should continue to anchor the front end of the U.S. yield curve, in our view. The Fund has a focus on the front end of the curve while being underweight at the long end, where we think there is more uncertainty.
Mortgage-backed securities
Our exposure to mortgage-backed bonds is mainly through Fannie Mae securities, where we are making selective investments in an effort to benefit from relative valuations. In the past quarter, this was a positive contributor to the portfolio. The remaining exposure in the mortgage-backed sector is from non-agency mortgages, which we view as a source of very attractive yields.
Developing economies
Emerging markets continue to be the bright spot in the global economy, driven by China. Our expectation for Chinese economic growth is about 6.75% to 7.25%, and for the rest of the emerging markets somewhere between 2.75% and 3.25%. We still believe in the secular growth story in Brazil, India, and Russia although each of those countries is facing some short-term difficulties.
Steep yield curve
We're avoiding the risk of rising rates at the very long end of the yield curve, focusing instead on the front end. We hope to take advantage of the steepness in that part of the curve to benefit from roll-down, or the price appreciation that takes place as bonds move closer to maturity.
Moderate growth in Japan
We anticipate economic growth in the range of 1% to 1.5% for Japanese markets. They have been successful in lowering the exchange rate as well as increasing their inflation rate. But we still expect growth to be relatively slow since they have not been able to address some of the structural reforms that were meant to be the third arrow of Prime Minister Shinzo Abe's strategy to revive the country's sluggish economy.

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.