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Real Return Fund —
The Fund outperformed its benchmark and the bond market
3rd Quarter, 2017
"The Fed will likely continue along its trajectory of gradual tightening, in our estimation; we anticipate two or three rate hikes between now and the end of 2018. "
– Pacific Investment Management Company LLC

Although rising geopolitical tensions and political dysfunction in the U.S. characterized most of the third quarter of 2017, markets appeared to roll with the punches as a solid fundamental backdrop continued to support a robust risk appetite. Though rates fell for much of the quarter, a shift toward reduced accommodation by developed market central banks pushed yields in developed markets higher toward the end of the period.
Developed market central banks continued to shift toward diminished policy support as the U.S. Federal Reserve (Fed), European Central Bank, and Bank of England indicated reduced accommodation in the form of rate hikes, tapering or balance sheet normalization. As the broader risk rally continued, volatility remained low, equities strengthened, and credit spreads tightened. Emerging market assets broadly continued to strengthen on the back of healthier fundamentals and rising oil prices, despite a more hawkish Fed.
The Harbor Real Return Fund posted a return of 1.10% for the third quarter, outperforming the 0.86% return of its benchmark, the Bloomberg Barclays U.S. TIPS Index. The TIPS index performed in line with the Bloomberg Barclays U.S. Aggregate Bond Index, a diversified benchmark of investment-grade bonds, which had a return of 0.85%.
The Fund invests primarily in inflation-linked bonds issued by the U.S. and other governments. During the third quarter, the Fund’s U.S. real interest rate strategies, global relative value strategies, and out-of-benchmark allocation to non-agency mortgage-backed securities all contributed to relative returns.
PIMCO’s comments were made in an October, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended September 30, 2017, unless otherwise indicated. All references to the year-to-date are for the period January 1 through September 30, 2017.

Interview Highlights

How Our Strategies Performed
During the third quarter, the Fund’s tactical duration positioning helped drive outperformance versus its benchmark. We remained overweight breakeven inflation in the U.S., given expectations that remain below levels we believe are justified in light of strong core inflation dynamics and upside risks stemming from Trump’s proposed policies. An overweight to Treasury Inflation-Protected Securities (TIPS) had a positive impact on relative returns, as did our modest allocation to non-agency mortgage-backed securities, which we consider to have attractive loss-adjusted yields and which are underpinned by a strong housing market.
We Anticipate Steady Growth
We believe that world Gross Domestic Product (GDP) growth in 2018 could remain steady at 2.75% to 3.25%, unchanged from 2017. Overall, we see a low near-term risk of recession, a moderate pickup in underlying inflation in the advanced economies, mildly supportive fiscal policies and only a gradual removal of accommodative central bank policy. In the U.S., we are anticipating growth may not reach consensus-predicted levels in 2018, possibly ending up in the 1.75% to 2.25% range, albeit still above trend, should the U.S. expansion continue to mature and slack in the labor market keep eroding. We believe core inflation could increase to 2% over the course of 2018, with some upward pressure on wages. The Fed will likely continue along its trajectory of gradual tightening, in our estimation; we anticipate two or three rate hikes between now and the end of 2018.
International Outlook
For the eurozone, we believe that growth could rise to a range of 1.75% to 2.25% in 2018, significantly above trend. A key risk for the outlook is the Italian elections in the first half of 2018, although the political risk looks more contained than earlier this year, as political parties skeptical about the European Union have toned down their rhetoric. In the U.K., we believe growth could be in the range of 1.25% to 1.75% for the balance of 2017 and into early 2018. Our base case is that a transitional arrangement may smooth the U.K.’s separation from the European Union and that growth could reaccelerate should business confidence pick up. We believe Japan’s GDP growth could moderate somewhat to 0.75% to 1.25% in 2018 but remain above trend, reflecting ongoing fiscal and monetary support as well as decent global growth. In China, we believe growth could decelerate in 2018, reflecting uncertainty about the leadership’s prospective stance on financial stability, deleveraging and economic growth following the Party Congress. We are optimistic that economic recoveries in Brazil and Russia could become more entrenched.

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