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High-Yield Bond Fund —
Fourth Quarter Manager Commentary
1st Quarter, 2019
"We believe that with more global fixed income assets offering negative yields, low global growth, and stable U.S. interest rate expectations, investors may increasingly look for quality credits offering yield and avoid chasing risk for principal gains. "

Economic Overview
After a negative year of returns for high yield in 2018 and a challenging fourth quarter, the leveraged finance asset classes have rebounded dramatically thus far in 2019. This rebound occurred after a rapid change in the U.S. Federal Reserve (the Fed) chair’s tone and positive inflows helped technical conditions. The ICE BofAML U.S. High Yield Index (H0A0) returned 7.4% in the first quarter of 2019 and 4.6% in January alone. After starting 2019 with a yield-to-worst of 7.9% and an option adjusted spread of 533 basis points (bps), by quarter-end the index was at 6.35% and 372 bps, respectively.
Concerns over global growth, political instability, and U.S.–China trade negotiations all still loom over markets, but the Chinese economy has appeared to improve after stimulus measures, while its stock market has rallied. Perhaps the most dramatic news during the quarter was from the U.S., as the Fed reversed its outlook for interest rate hikes, which triggered the best high yield returns in longer duration issues in the index. Within the index for the quarter, bonds with an option adjusted duration (OAD) of two to four years had a return of 6.73%, while those with a six-year or greater OAD returned 9.89%. For the quarter, returns by rating category were fairly consistent, as BB-rated bonds in the index returned 7.38%, while B-rated bonds rose 7.27% and CCC-rated bonds gained 7.90%.
Portfolio Review
In the first quarter of 2019, the Harbor High-Yield Bond Fund (Institutional Class) returned 6.53%, underperforming its benchmark, the ICE BofAML US Non-Distressed High Yield Index, which returned 7.26%.
During the quarter, a decline in interest rates supported a broad rally in fixed income securities. Additionally, the increase in stock prices during the quarter served to increase the perceived equity cushion underneath the debt components of companies’ capital structures.
Negative security selection effects in the Media: cable industry and the oil and gas industry detracted from relative performance during the quarter. In contrast, contributors to relative results included security selection in non-food and drug retailers, as well as security selection and an underweight position in aerospace and defense. Security selection in BB-rated and B-rated credits hindered relative performance, while security selection and an underweight position in credits rated CCC and below helped. In addition, the Fund’s out-of-index allocation to bank loans performed well but less than the high yield market.
During the quarter, we made no significant changes to the Fund. However, the Fund has continued to benefit from shifts that occurred during 2018—increasing the Fund’s exposure to BB-rated credits and credit we deemed to be more liquid, while decreasing exposure to CCC-rated credits.
We do not believe the Fed will raise rates this year and will likely curtail its balance sheet unwinding by year end. We continue to believe U.S. Gross Domestic Product could expand at a 2.0% to 2.5% rate this year. We believe the current benign interest rate environment is supportive of U.S. high yield markets and a pickup in high yield new issuance. The 10-year U.S. Treasury yield and U.S. three-month London Interbank Offered Rate dropped about 30 bps and 20 bps, respectively, during the quarter, which we believe may lead to increased refinancing and more merger and acquisition activity as cost of capital is recalibrated. Lower U.S. economic growth expectations than last year may help extend economic expansion, as we think asset value bubbles and bad corporate investment are less likely. We believe that with more global fixed income assets offering negative yields, low global growth, and stable U.S. interest rate expectations, investors may increasingly look for quality credits offering yield and avoid chasing risk for principal gains.

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