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Unconstrained Bond Fund —
Reversing course, bonds post positive returns for Q1
1st Quarter, 2014
"In mortgage-backed securities, we really like the non-agency market. We think it provides a great degree of value. "
– Pacific Investment Management Company LLC

Investment-grade bonds moved higher in the first quarter of 2014, reversing direction after finishing the prior year in negative territory. The Barclays U.S. Aggregate Bond Index, a measure of the broad taxable U.S. bond market, returned 1.84% for the three months ended March 31, 2014. By comparison, the index had a negative return of -2.03% for calendar 2013. The BofA Merrill Lynch US Dollar 3-Month LIBOR Constant Maturity Index recorded a positive return of 0.06% for the first quarter of 2014.
The Harbor Unconstrained Bond Fund began the new year with a return of 0.86% for the first quarter. It had posted a flat return of 0.00% for calendar 2013. The Fund is managed by Bill Gross, managing director, chief investment officer, and founding partner of Pacific Investment Management Company (PIMCO).
Portfolio strategies designed to benefit from rising interest rates hurt performance in the first quarter as rates declined, the PIMCO team reports. Holdings in non-agency mortgage-backed securities were a positive contributor to returns, as were investments in investment-grade corporate bonds and high yield securities.
PIMCO’s comments were made in an April 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2014.

Interview Highlights

Reducing duration
The total duration of the portfolio is about 2.1 years, which is substantially shorter than it was at the end of December. We are adding exposure to short-dated securities issued by companies in housing-related, finance, and energy industries.
Adding value
In mortgage-backed securities, we really like the non-agency market. We think it provides a great degree of value. Attractive yield levels are still available in those securities and supply currently is very limited. Non-agency holdings are about 15% of the portfolio, so this continues to be one of the key ways for us to add value and provide incremental yield.
Comparing valuations
We have reduced our Fannie Mae positions substantially. We’re now at about 3% of the portfolio, while at the end of December we were closer to 10%. That is a valuation-driven call, essentially reflecting our view that non-agencies currently provide the best opportunities in the mortgage-backed market.
Falling yields
Bond yields generally declined over the first quarter. The yield of the 10-year U.S. Treasury note fell 31 basis points to end the quarter at 2.72%. In most developed and emerging markets, yields rallied, with notable outperformance in European peripherals like Greece, Portugal, and Spain.
Emerging markets
In terms of emerging markets, we expect China to continue to be the growth engine, with GDP growth in a range of about 6.5% to 7.5%. Other emerging markets should add about 3%, in our view. Export-driven growth in the developing world should continue to be highly dependent on the economic health of developed markets, where most of their ultimate consumers reside.

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.