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Unconstrained Bond Fund —
Bonds register modest Q3 return
3rd Quarter, 2014
"Our currency strategies reflect a belief that the U.S. Dollar will continue to grow stronger and that the Mexican Peso also will benefit in the current environment. "
– Pacific Investment Management Company LLC

U.S. investment-grade bonds posted slightly positive returns for the third quarter of 2014, as the Barclays U.S. Aggregate Bond Index, a measure of the broad taxable investment-grade U.S. bond market, returned 0.17%. U.S. Treasuries moved higher in the quarter, while Treasury Inflation-Protected Securities lost ground as inflation expectations declined. Also for the third quarter, the BofA Merrill Lynch US Dollar 3-Month LIBOR Constant Maturity Index recorded a return of 0.06%.
In this environment, the Harbor Unconstrained Bond Fund posted a return of 0.19% for the third quarter. The Fund is managed by Saumil Parikh, Mohsen Fahmi, and Daniel Ivascyn of Pacific Investment Management Company (PIMCO).
Currency positioning helped Fund performance in the third quarter as the Euro and Japanese Yen weakened against the U.S. Dollar, the PIMCO team reports. An allocation to non-agency mortgage-backed securities also boosted performance, as did exposure to short-maturity bonds in Italy and Spain. The Fund had an emphasis on short and intermediate maturities, offsetting that with an underweight to the long end of the yield curve; this detracted from performance as yields rose in the short-to-intermediate part of the curve. Bond yields rise as prices fall. An exposure to corporate credits also detracted from returns as yield spreads widened between corporates and like-duration Treasuries.
PIMCO's comments were made in an October 15, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended September 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through September 30, 2014.

Interview Highlights

Trimming duration
We have reduced the duration of the Unconstrained Bond Fund, taking it down to about 2.15 years. We are gradually adding to short-dated corporate credits while focusing on sectors that we believe have high barriers to entry, strong growth, and strong pricing power. For example, housing, energy, and finance are some of the areas that we have been favoring.
International positioning
In emerging markets, we continue to favor high quality creditor countries, especially Brazil and Mexico. We also have exposure to some of the EU peripheral countries, but it is relatively small. Our currency strategies reflect a belief that the U.S. Dollar will continue to grow stronger and that the Mexican Peso also will benefit in the current environment. We are currently underweight the Euro and the Japanese Yen, and have a long position in the Mexican Peso.
Housing recovery
Non-agency mortgage-backed bonds continued to benefit from an ongoing recovery in housing as well as demand for higher-yielding assets. The sector also benefited from a limited new-issue supply during the quarter. We are maintaining our holdings in the non-agency mortgage-backed sector, which continues to be a sizable part of the portfolio, about 15%. We have almost completely eliminated our exposure to U.S. agency mortgages, which in our view appear to be richly valued and will no longer benefit from Federal Reserve purchases as the Fed winds down its quantitative easing program.
Demographic headwinds
In Japan, we expect about 1% to 1.5% growth. Japan continues to face headwinds, mainly through demographic decline, as its population is aging at a faster rate than in other developed markets. There is also uncertainty about fiscal policy. They have been able to improve some of their growth prospects through actions of the Bank of Japan but until they are able to get a firmer footing on other aspects of economic policy, it is unclear whether they will able to sustain the growth rates they've seen in the past few quarters.

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

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.