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Unconstrained Bond Fund —
Bonds gain ground amid improved investment climate
2nd Quarter, 2014
"In this type of environment we think it becomes especially important to pick your spots carefully and use active management to add value. "
– Pacific Investment Management Company LLC

Fixed income investments delivered positive returns for the second quarter of 2014. The Barclays U.S. Aggregate Bond Index returned 2.04%, which includes price appreciation and interest payments, for the three months ended June 30, 2014. The index is a measure of the broad taxable U.S. bond market. The BofA Merrill Lynch US Dollar 3-Month LIBOR Constant Maturity Index recorded a positive return of 0.06% for the second quarter.
The Harbor Unconstrained Bond Fund recorded a return of 1.70% for the second quarter. The Fund is managed by Bill Gross, managing director, chief investment officer, and founding partner of Pacific Investment Management Company (PIMCO).
Equities and bonds both gained ground in the second quarter as markets reflected a somewhat improved investment climate and increased appetite for risk, the PIMCO team reports. Interest rate strategies in the U.S. contributed to Fund performance in the quarter, as did investments in non-agency mortgage-backed securities, corporate bonds, emerging markets debt, and municipal bonds. Positioning in Italy, Spain, Mexico, and Brazil also added value, while strategies in the United Kingdom and Canada detracted from returns.
PIMCO’s comments were made in a July 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended June 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through June 30, 2014.

Interview Highlights


Risk appetite
During the second quarter we saw a return of risk appetite as well as an easing of geopolitical risks around the world. Bonds and stocks both posted strong returns. Bond markets around the globe rallied, led by emerging markets, while yields in developed markets fell to 12-month lows. Equity markets also posted sizable gains, with the S&P 500 Index rising to an all-time high.
Active management
Given that we have had quite a rally in equities as well as in fixed income spread sectors, our view is that prospects for further appreciation could be muted going forward. In this type of environment we think it becomes especially important to pick your spots carefully and use active management to add value.
Portfolio positioning
We have taken down some of the duration positioning in the portfolio. We are now at about three years of duration. We’re concentrating on the front end as well the intermediate part of the yield curve and you will see us being basically underweight the 30-year part of the curve. We have been adding to short-dated credit exposures, mainly in housing, finance and energy. Non-agency mortgages make up about 15% of the portfolio overall. We are holding smaller amounts of the agency mortgage sector, which is consistent with our view that agency mortgages have rallied quite a bit and are no longer as attractive from a valuation perspective.
Foreign exposures
We hold some high quality credit positions outside the U.S. Spain and Italy are the largest areas. Italy is a sizable allocation, almost 12% of the portfolio. We think there is an opportunity to get additional yield for the portfolio in a relatively risk-controlled fashion because that sovereign credit is supported by overall policies and monetary policies in Europe. We also hold positions in Brazil and Mexico, which we believe are attractive from an economic perspective and provide higher yields than many of the developed-market countries.
Potential upgrades
We continue to maintain a sizable allocation to high yield securities in the portfolio, about 10%. While spreads obviously have compressed quite a bit, the key area of opportunity we see in high yield is through securities that we believe have a high degree of potential for being upgraded in the near-term. These are what we call rising stars and most of that exposure is coming through the finance, real estate, and medical sectors.

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.