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Real Return Fund —
Fourth Quarter Manager Commentary
2nd Quarter, 2019
"We have increased overall duration within the Harbor Real Return Fund while continuing to remain cautious. "

Market in Review
Despite heightened global trade tensions for much of the quarter, both safe haven and risk assets broadly rallied as central bank rhetoric struck even more accommodative tones amid mounting economic uncertainties. The Federal Reserve appeared to signal an easing bias as it dropped the word “patient” from its policy statement and indicated that it would act as appropriate to sustain the expansion. Similarly, the European Central Bank suggested that it was primed for additional stimulus in the form of rate cuts or quantitative easing. While risk sentiment moved in tandem with the ebb and flow of global trade tensions throughout the quarter, the S&P 500 still set new highs and credit spreads broadly tightened. Meanwhile, 10-year government bond yields fell in the U.S. and Germany – with the latter setting a new record low – and the U.S. yield curve inverted again.
An unanticipated escalation in U.S.-China trade frictions during the quarter precipitated a sell-off in risk assets. Some reprieve occurred, however, when President Trump retraced tariff threats on Mexico and agreed to proceed with U.S.-China negotiations at the G20 summit. Global economic data were mixed as optimism from better-than-expected growth in China at the start of the quarter was offset by continued signs of decelerating growth in other regions. Purchasing managers indexes (PMI) in several developed markets fell into contractionary territory and the U.S. index declined to its lowest level in nearly a decade (though remaining in expansionary territory).
Portfolio Performance
In the second quarter of 2019, the Harbor Real Return Fund (Institutional Class) returned 2.68%, underperforming its benchmark, the Bloomberg Barclays U.S. TIPS Index, which returned 2.86%.
Performance was impacted by cautious duration positioning, which detracted, as developed market rates saw a coordinated move lower as signs of slowing global growth pushed central banks into more accommodative stances. The Fund’s long U.S. position versus U.K. and eurozone breakeven inflation (BEI) rates was neutral for performance as global BEIs moved lower over the course of the second quarter in concert with oil prices and risk sentiment. Holdings in agency mortgage-backed securities detracted from Fund performance as the sector underperformed similar duration Treasuries. Exposure to a basket of high-carry emerging market currencies was positive for performance.
Portfolio Positioning
The Fund maintained a cautious duration position overall and favored a steepening bias on the U.S. yield curve given the likely return of term premium. Duration positioning detracted from performance as developed market rates saw a coordinated move lower as signs of slowing global growth pushed central banks into more accommodative stances. The Fund was, and remains, long U.S. versus U.K. and eurozone breakeven rates given that U.S. breakeven inflation expectations remain below long-term value. This was neutral for performance as global BEIs moved lower over the course of the second quarter in concert with oil prices and risk sentiment.
Within spread strategies, the Fund was long agency mortgage-backed securities, which detracted from performance, as the sector underperformed similar duration Treasuries. We continue to have modest exposure to agency mortgages given attractive valuations and higher yields. Currency strategies, including exposure to the Argentine Peso and Russian Ruble, contributed to performance. We remain tactical with currency positioning and continue to emphasize a diversified basket of higher carry emerging market currencies.
Contributors and Detractors
During the second quarter, our currency strategies, including long exposure to a basket of high-carry emerging market currencies, together represented the largest contributor to relative returns. These currencies, particularly the Argentine Peso and Russian Ruble, appreciated relative to the U.S. Dollar during the quarter.
Although it was the largest detractor in the account, we remain cautious overall with duration positioning, which is sourced primarily in an underweight to U.K. and select European nominal rates given rich valuations.
Buys and Sells
We have increased overall duration within the Fund while continuing to remain cautious. We anticipate interest rates in the U.S. to be relatively range bound. Although U.S. yields have fallen, we believe U.S. duration is still attractive given the potential for capital appreciation (i.e., U.S. rates have more room to fall) in adverse market environments.
Outlook
In the U.S., we continue to anticipate growth to slow to 2% to 2.5% in 2019 from nearly 3% last year. Factors contributing to the deceleration include fading fiscal stimulus, the lagged effect of tighter monetary policy over the past few years, and headwinds from the China-global slowdown. Headline inflation is likely to remain in the 1.5% to 2% range this year, we believe, while core Consumer Price Index ("CPI") moves sideways. With growth likely to continue slowing through the year and inflation remaining below target, the Fed has adopted a more dovish stance and looks likely to cut rates by 50 basis points by year-end 2019, in our view. In response, U.S. duration exposure, both nominal and real, increased meaningfully during the quarter.
On the global front, we anticipate eurozone growth to slow to a trend-like pace of 0.75% to 1.25% in 2019 from close to 2% in 2018, as weak global trade exerts significant downward pressure on the economy and some countries experience a recession. In the U.K., we anticipate real growth in the range of 1% to 1.5% in 2019, modestly below trend, and we continue to believe that a chaotic no-deal Brexit is a lower-probability event. We believe Japan’s GDP growth to be modest at 0.5% to 1% in 2019, broadly unchanged from 0.7% in 2018. Lastly, we believe China’s growth may slow in 2019 to the middle of a 5.5% to 6.5% range from 6.6% in 2018, stabilizing somewhat in the second half of the year as fiscal and monetary stimulus find some traction.

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 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.