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More Confidence in This Silver-Rated Bond Fund

There's reason for continued optimism as Harbor Bond Fund's subadvisor PIMCO settles into a new era.

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The following is our latest Fund Analyst Report for Harbor Bond Fund (HABDX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

We've long had confidence in Harbor Capital Advisors. Moreover, we recently upgraded subadvisor PIMCO's Parent rating to Positive, and our Morningstar Analyst Rating for  PIMCO Total Return (PTTRX)--upon which strategy this fund is built--to Silver. As such, we are raising this fund's rating to Silver from Bronze.

Even under Bill Gross, the backbone of PIMCO's success had been a massive staff of managers and analysts. Major cracks in that foundation would have been a red flag, but they haven't materialized. There has been minimal turnover since Gross' departure, and the team here has found balance among its three leaders. The staff has also been augmented in some cases by senior-level returnees to the firm. Those features contribute to Morningstar's strong confidence in PIMCO as a whole.

This fund is led by Scott Mather, Mihir Worah, and Mark Kiesel (a 2012 Morningstar Fund Manager of the Year), along with the oversight of group CIO Dan Ivascyn (himself a 2013 winner of the award). The latter is a crucial component for any PIMCO-led offering, given the importance of macro-level decisions at the Investment Committee level. That body, too, has appeared to benefit from adjustments made--in part to include more bottom-up input--even before Gross left.

As of early 2017, the fund's bigger-picture themes included a shorter-than-benchmark duration, reflecting PIMCO's position that the market's inflation expectations were too low. The firm also viewed corporate-debt valuations warily, a sentiment reflected here with a relatively light exposure to credit overall.

There have been hiccups, including a misread of the Fed response to global market shifts in late 2015 and early 2016, which made for modestly inconsistent returns. But with the benefit of a strong year through April 30, 2017, the fund's three-year returns placed in the best third of its (distinct) peers, mostly consistent with its longer-term success. This well-priced, low-minimum offering, backed by a very strong asset manager, continues to deserve investor confidence.

Process Pillar: Positive | Eric Jacobson 05/09/2017
As managers here since September 2014, Scott Mather, Mark Kiesel, and Mihir Worah haven't made any big changes to the fund's strategy. All are members of PIMCO's Investment Committee, and while Mather serves as the tiebreaker with input from Kiesel and Worah, it has become clear that he mostly functions as the fund's lead manager.

It is also clear that PIMCO remains committed to having macro-level themes shape its funds' interest-rate and sector exposures. That makes the smooth functioning of its Investment Committee, which has undergone a number of changes during the past few years, particularly important to the fund's success. Efforts to improve that body's effectiveness by adding bottom-up thinkers such as Kiesel and group CIO Dan Ivascyn, investing in the quantitative tools and people backing the firm's macroeconomic research, and encouraging dissent and healthy debate have all been reassuring.

Today's Investment Committee is designed to do a better job of channeling the expertise of PIMCO's talented investors into a coherent and successful strategy, and the combined effort earns the fund a Positive Process rating.

This fund has historically drawn from a broad tool kit. Former manager Bill Gross actively adjusted the fund's exposures to the traditional core bond sectors of Treasuries and other government fare, mortgages, and corporates, and he would hold meaningful stakes in non-U.S. developed and emerging markets, as well as high-yield debt. That approach continues under the current leadership. As of March 2017, the strategy had a duration roughly 15% short of the Bloomberg Barclays U.S. Aggregate Bond Index's, reflecting PIMCO's view that market inflation expectations were too low. While mostly owing to U.S. market exposure, it reflected a focus on bonds with three- to five-year maturities and overall short exposure to interest rates among non-U.S. developed markets. Exposure to corporate credit--in the 19% range and inclusive of a low-single-digit slice of high yield--reflected an underweighting to the index. Both the non-U.S. and high-yield allocations represented exposures outside of the index, as did very short-maturity emerging-markets allocations (roughly 10%).

The latter represents a notable shift, in that emerging-markets debt constituted around one fourth of the fund's market value in March 2015. The fund's TIPS were buffeted along with oil prices and global inflation expectations in 2015, but they rallied in 2016 and were slashed to the mid-single digits as of March 2017, down from more than 15% a year earlier.

Performance Pillar: Positive | Eric Jacobson 05/09/2017
When managers leave, it often makes sense to discount a fund's past performance. However, group CIO Dan Ivascyn and this fund's three comanagers have long been contributors to the success of the firm and the fund.

So, it makes sense to give some attention to the fund's prior record. True, the fund had run into several difficult stretches on Bill Gross' watch. During 2011, for example, a relatively short duration and limited exposure to government bonds hurt in the year's rocky third quarter as long-term Treasuries rallied. The fund was also tripped up in the summer of 2013, in part because of a spike in long-maturity yields that hit its TIPS allocation especially hard and its exposure to sinking emerging-markets debt.

The fund had a better 2015 overall but was buffeted late in the year and again in early 2016, in part thanks to a misreading of Fed responses to global markets and inflation. Overall, its three- and five-year gains through April 30, 2017, placed roughly at the best third of (distinct) funds in the intermediate-term-bond Morningstar Category. Despite its occasional missteps, however, the fund's returns in recent years haven't put it badly out of step with its category, and its longer-term record remains topnotch, supporting a Positive Performance rating.

People Pillar: Positive | Eric Jacobson 05/09/2017
Bill Gross' September 2014 departure from PIMCO for Janus was momentous. However, he left behind an enormous staff of talented managers and analysts that he had hired and trained over the years, and they have stepped up to take on important roles in his absence.

The three portfolio managers who replaced Gross here all came to the job with impressive and complementary resumes. Prior to taking over, Scott Mather, who has final decision-making responsibility on the portfolio, had served a number of roles across PIMCO, including a stint co-heading the firm's mortgage- and asset-backed securities group and, most recently, running its global portfolio management team. Mark Kiesel, Morningstar's 2012 Fixed-Income Fund Manager of the Year, heads up the firm's global credit effort. Mihir Worah rounds out the team and brings important perspective from his role heading the firm's real return and multiasset portfolios. Finally, although not a named portfolio manager here, group CIO Dan Ivascyn has an impressive record in his own right, which includes recognition as Morningstar's 2013 Fixed-Income Fund Manager of the Year. All four are permanent members of the firm's Investment Committee.

Overall, PIMCO's staff has tremendous depth, boasting world-class practitioners and intellects across the board, including several hired in the past year, supporting the fund's Positive People rating.

Parent Pillar: Positive | Eric Jacobson 05/08/2017 
Harbor Capital Advisors is known for hiring best-in-class subadvisors to run its funds. Harbor is a wholly owned subsidiary of Dutch asset manager Robeco Groep N.V., which has remained hands-off as a parent since first acquiring Harbor in 2001. Robeco was sold in mid-2013 to the Japanese financial-services firm ORIX, but Harbor has reported enjoying the same independence that it has had all along.

Harbor will continue to select and monitor managers on its own terms. (It has chosen not to use any Robeco managers, for instance.) A 10-person research team favors managers with a history of consistent risk-adjusted performance and repeatable strategies. Most of those managers invest alongside shareholders, with the majority holding more than $1 million in the strategies they run. Subadvisor changes have been rare, as evidenced by an average manager tenure of 8.2 years and a five-year manager-retention rate of 94%.

The firm's small target-date series is on the expensive side, but Harbor also offers access to topnotch managers at prices cheaper than are available elsewhere. For example, the institutional share class of the small Harbor Real Return fund has a 0.54% expense ratio. Yet PIMCO Real Return--the fund on which it is modeled--is roughly 110 times its size, and its comparable share class charges 0.85%.

Price Pillar: Positive | Eric Jacobson 05/09/2017 
At 0.51%, this fund's price tag technically has a Morningstar Fee Level of Average relative to other institutional share classes. However, the fund is available to investors with a relatively low minimum of $1,000, and its fees--which represent a slight drop from previous years--register as below average relative to no-load options in the intermediate-bond category, supporting a Positive Price score. It's possible to get roughly the same portfolio in the form of PIMCO Total Return's Institutional shares for 46 basis points, but that's very difficult without at least $1 million or access via a 401(k) or other so-called omnibus account.

Eric Jacobson has a position in the following securities mentioned above: PTTRX. Find out about Morningstar’s editorial policies.