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Unconstrained Bond Fund —
The Fund’s currency and non-agency mortgage positions faced headwinds in the quarter
1st Quarter, 2016
"We believe that liquidity and the easing policies of central banks continue to be advantageous for spreads. "
– Pacific Investment Management Company LLC

The Harbor Unconstrained Bond Fund saw mixed results in the first quarter of 2016, with some of its strategic allocations contributing and others detracting. The Fund’s allocation to non-agency mortgage-backed securities detracted, as did its currency positioning. On the positive side, interest rate strategies contributed, as did corporate bond and high yield bond holdings. The Fund posted a negative absolute return of -0.84% for the quarter. For comparison, its benchmark, the BofA Merrill Lynch US Dollar 3-Month LIBOR Constant Maturity Index, returned 0.15%.
In the market environment of the first half of the quarter, when investors fled riskier assets and flocked toward safer havens, non-agency mortgage-backed securities held by the Fund detracted. Elements of the Fund’s currency positioning that weighed on results included positions that stood to benefit from depreciation of the Brazilian Real and the Chinese Renminbi, which instead appreciated versus the U.S. Dollar.
On the positive side, the Fund benefited from security selection among investment grade and high yield bonds, in a quarter during which spreads ended largely flat despite volatility along the way. Positioning relative to U.S. break-even inflation rates also contributed, as U.S. growth and inflation expectations recovered over the quarter.
PIMCO’s comments were made in an April 14, 2016 interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through March 31, 2016.

Interview Highlights

Mortgage-Backed Securities
We continue to find attractive value in non-agency mortgages. That’s not coming as a surprise because that’s a position we’ve held for a very long time. We have close to 30% of the portfolio invested in non-agencies. And that continues to be an area that we view as a very good opportunity. It's still yielding a nice premium over most of the traditional mortgages with very good credit quality characteristics, so we believe that it's very advantageous to hold on to the bonds that we have.
In terms of credit markets, we have long positions in both investment grade and high yield. We believe that liquidity and the easing policies of central banks continue to be advantageous for spreads. We slightly decreased our allocations in these areas over the quarter, to 18.8% for investment grade and 12.5% for high yield. We believe that the market for these credit sectors continues to be well supported for at least the next 12 to 18 months.
Emerging Market and Currency Positioning
In terms of emerging markets, we've taken Mexico down to about 1% or so. Brazil is down to about 8%. So that's a pretty sizable move. Brazilian exposure was almost 20% at one point in time, but we've taken it down to limit some of the exposure. We actually expect that the overall outlook in Brazil may be improving, with some movement toward changing leadership, and we believe that improves prospects for Brazilian growth. That, as a counterbalance, then reduces the likelihood that there will be further cuts in the Brazilian rates, supporting the performance of bonds. On the currency side, we've also taken some of those currency positions down. They are smaller than they were in the past. We've got a short of 3% in the Chinese Renminbi, and we've established short positions of about 2% in the Euro and 1% in the Yen.

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