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Unconstrained Bond Fund —
Non-agency mortgages helped drive Unconstrained Bond Fund's Q1 performance
1st Quarter, 2013
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"We continue to maintain a pretty conservative approach when it comes to duration. "
– PIMCO Investment Strategy Group

In a challenging environment for fixed income securities, the Harbor Unconstrained Bond Fund recorded a return of 1.94% for the first quarter of 2013. By comparison, the BofA Merrill Lynch US Dollar 3-Month LIBOR Constant Maturity Index returned 0.08%, while the broad taxable U.S. bond market, as measured by the Barclays Capital U.S. Aggregate Bond Index, had a negative return of -0.13%.
For the 12 months ended March 31, the Harbor Unconstrained Bond Fund returned 8.79% compared with 0.43% for the BofA Merrill Lynch US Dollar 3-Month LIBOR Constant Maturity Index and 3.77% for the Barclays Capital U.S. Aggregate Bond Index. The Fund is managed by Chris Dialynas, a managing director of Pacific Investment Management Company (PIMCO).
Favorable strategies in the first quarter included exposure to non-agency mortgage backed securities, which proved to be the Fund's largest contributor to performance, PIMCO reports. The Fund also maintained an exposure to municipal securities, in particular Build America Bonds; this was a positive as the sector benefited from tightening spreads. The portfolio also had exposures to Australian and Brazilian interest rates, which rose over the quarter and thus detracted from performance.
PIMCO's comments were made in an April 12, 2013, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2013, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2013.

Interview Highlights

Yield curve positioning
We like the 5 to 10 year part of the yield curve and that's where we want to maintain most of our exposure. We think the long end of the curve is expensive, especially in light of the potential inflation risk we see, so we're underweight at the very long end.
Conservative approach
We continue to maintain a pretty conservative approach when it comes to duration. We are quite close to the neutral point in terms of duration positioning. We tend to use countries that we believe have the best balance sheets and also offer yield levels that compensate investors for taking interest rate risk. These include the United States, Canada, Australia, Brazil, and Mexico.
Adding value
Mortgages are fully valued on the agency side, in our view. However, we believe non-agencies still represent a great opportunity for investors in terms of yield. In addition, they are a relatively high credit quality investment overall. We are holding non-agency mortgages and commercial mortgage backed securities in the portfolio as one of the ways of adding value and enhancing yield.
Trimming corporate exposure
We have been reducing our corporate allocation. At the beginning of the year, for example, we had about 4.4% of the Fund invested in the corporate sector. Now we're at about 2.4%, so that has come down substantially.
Monetary boost for Japan
We believe the recent shift in Japanese monetary policy could be quite substantial in its impact on the Japanese economy. In our minds, Japan is now at a place where it could grow between 1.25% to about 2.25% in the coming cyclical period. That is a substantial change in our expectations.

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.