Foreign Bond Fund
(U.S. Dollar-Hedged)
PFORX | UPDATED NOVEMBER 16, 2016

Chairman’s Letter

On the following pages of this PIMCO Funds Semiannual Report, which covers the six-month reporting period ended September 30, 2016, please find specific details regarding investment performance and a discussion of factors that most affected performance over the reporting period.

IMCO announced on July 19, 2016 that the firm’s Managing Directors have selected Emmanuel (Manny) Roman as PIMCO’s next Chief Executive Officer effective November 1, 2016, and PIMCO’s former CEO Douglas Hodge assumed a new role as Managing Director and Senior Advisor effective on the same date.

The announcement of Mr. Roman as PIMCO’s CEO was the culmination of a process undertaken by the firm to hire a senior executive who would add leadership and strategic insights combined with a deep appreciation of PIMCO’s diversified global businesses, investment process and focus on superior investment performance and client-service. Mr. Roman’s appointment has the full support of the firm’s leadership including Mr. Hodge, PIMCO’s President Jay Jacobs, the firm’s Executive Committee and its Managing Directors. Mr. Roman has nearly 30 years of experience in the investment industry, with expertise in fixed income and proven executive leadership, most recently as CEO of Man Group PLC, one of the world’s largest publicly-traded alternative asset managers and a leader in liquid, high-alpha investment strategies.

Financial market highlights of the six-month reporting period include:

  • The unexpected outcome of the U.K. referendum in June 2016 dominated headlines and market movements during the first half of the reporting period. Departing from the trend prevalent for the first two months of the period, volatility rose in June as sovereign yields rallied significantly while risk assets generally underperformed. Still, the fundamental backdrop remained mostly intact and expectations for further central bank easing helped anchor risk appetite. Steadier commodity prices and fiscal stimulus in China helped bolster market sentiment, even as central banks remained on hold ahead of the Brexit referendum. Softer-than-expected employment data in the U.S. pushed market expectations for the next Federal Reserve (“Fed’) interest rate hike further out into the future.
  • During the second half of the reporting period, markets generally shook off the surprising result of the Brexit referendum, along with a host of political developments including new leadership in the U.K. and Brazil, a coup attempt in Turkey, and an increasingly acrimonious presidential race in the U.S. In this environment, volatility generally remained low and risk assets rallied. Central banks featured prominently in the headlines as monetary policy concerns (in particular, the longevity of central bank support) lingered beneath the seemingly benign market environment. The Bank of Japan’s “comprehensive review,” inaction by the European Central Bank (“ECB”), and the Fed’s solidifying path towards a potential interest rate increase in December 2016 all contributed to sovereign yields generally rising during this period. Still, equities moved higher (U.S. stock indices set record highs), credit spreads tightened, and emerging market assets continued to gain.
  • U.S. Treasury yields between 1-month through 3-years generally rose, but 2-year yields were flat. The rise in Libor and the potential for a year-end interest rate increase by the Fed caused shorter-term U.S. Treasury yields to rise over the reporting period. In contrast, the growth of negative yielding sovereign and corporate debt in certain global regions and investor fears of slowing global growth led to a flight-to-quality in intermediate- to long-term U.S. Treasuries, where yields generally declined. The yield on the benchmark ten-year U.S. Treasury note was 1.60% at the end of the reporting period, compared with 1.78% on March 31, 2016 (the end of the previous reporting period). U.S. Treasuries, as measured by the Bloomberg Barclays U.S. Treasury Index, returned 1.81% over the reporting period. The Bloomberg Barclays U.S. Aggregate Index, a widely used index of U.S. investment grade bonds, returned 2.68% over the reporting period.
  • U.S. Treasury Inflation-Protected Securities (“TIPS”), as represented by the Bloomberg Barclays U.S. TIPS Index, returned 2.69% over the reporting period. Real interest rates generally declined over the reporting period on risk-off sentiment surrounding the U.K. referendum. Breakeven inflation dropped in the first part of the period as demand for nominal U.S. Treasuries outpaced that of U.S. TIPS, but meaningfully recovered in the last half of the period due to the rally in oil and stronger inflation prints.
  • Diversified commodities, as represented by the Bloomberg Commodity Index Total Return, returned 8.42% over the reporting period. The rebound in commodities was led by the energy sector, which saw choppy price movements for most of the first half of the period before rebounding in the second half of the period on the back of OPEC talks of a potential production cut at their November 2016 meeting and constructive inventory data. Agriculture commodities were mixed over the period, while precious metals posted positive returns on flight-to-quality demand amidst uncertainty surrounding Brexit.
  • Agency mortgage-backed securities (“MBS”), as represented by the Bloomberg Barclays U.S. MBS Fixed Rate Index, returned 1.72% over the reporting period. Agency MBS modestly outperformed like-duration U.S. Treasuries despite heavy issuance, amid continued Fed reinvestment activity and strong demand from banks and overseas investors. Non-Agency MBS returns were also positive amid limited new supply, a recovering residential real estate market and favorable representation and warranty settlement developments.
  • The U.S. investment grade credit market, as represented by the Bloomberg Barclays U.S. Credit Index, returned 4.76% over the reporting period. Investment grade credit spreads tightened during the period given continued accommodative monetary policy action from global central banks and a positive technical backdrop. The high yield bond market, as represented by the BofA Merrill Lynch U.S. High Yield Index, returned 11.69% over the reporting period, due to the strong recovery experienced by commodity companies and triple-C credits.
  • Tax-exempt municipal bonds, as represented by the Bloomberg Barclays Municipal Bond Index, returned 2.30% over the reporting period. Positive returns were supported by persistent demand for tax-exempt income, as flows into municipal bond mutual funds helped absorb elevated new issue volume. Credit spreads tightened and the high yield municipal bond segment outperformed, driven by a rally in both tobacco and Puerto Rico domiciled securities. Puerto Rico’s relief rally was attributed to U.S. Congress passing legislation that appointed a federal oversight board and which may provide a framework for the restructuring of the island’s $70 billion debt complex.
  • Emerging market (“EM”) debt sectors were lifted by a combination of global drivers, including improving economic fundamentals, a growing appetite for risk assets and strong inflows into the asset class. Despite headwinds from the slowdown in China’s economy, returns were buoyed by the Fed’s slower tightening cycle and stable global commodity prices. In addition, political developments added a layer of idiosyncratic drivers to returns. EM external debt, as represented by the JPMorgan Emerging Markets Bond Index (EMBI) Global, returned 9.34% over the reporting period. EM local bonds, as represented by the JPMorgan Government Bond Index-Emerging Markets Global Diversified Index (Unhedged), returned 5.46% over the reporting period.
  • Global equities, including developed market and emerging market, generally posted positive returns as a result of renewed investor risk appetite and supportive global central bank policies. U.S. equities, as represented by the S&P 500 Index, returned 6.40% over the reporting period. Global equities, as represented by the MSCI World Index, returned 5.92% over the reporting period. EM equities, as measured by the MSCI Emerging Markets Index, returned 9.75% over the reporting period.

Thank you for the assets you have placed with us. We value your trust, and will continue to work diligently to meet your broad investment needs. If you have questions regarding any of your PIMCO Funds investments, please contact your account manager, or call one of our shareholder associates at 888.87.PIMCO (888.877.4626). We also invite you to visit our website at www.pimco.com to learn more about our views and global thought leadership.

Sincerely,

Chairman Sign

Brent R. Harris

Chairman of the Board
PIMCO Funds