NORTHERN FIXED INCOME FUNDS

Transcription

1 NORTHERN FIXED INCOME FUNDS ANNUAL REPORT MARCH 31, 2018

2 A MESSAGE FROM BOB BROWNE CHIEF INVESTMENT OFFICER The U.S. bond market experienced headwinds in the 12-month period ended March 31, 2018 (the Period ), but the BloombergBarclaysU.S.AggregateBond Index a measure of performance for domestic, investment-grade bonds nonetheless posted a modest gain of 1.20% during the period ended March 31, Bond market conditions were fairly stable for the majority of the Period, with U.S. Treasury yields trading in a tight range through the middle of December. Although the U.S. Federal Reserve was in the midst of an interest rate tightening cycle, investors generally remained confident that a combination of moderate growth and muted inflation would allow the U.S. Federal Reserve to maintain a gradual approach to raising interest rates. This backdrop began to change late in 2017, however, when the passage of a sweeping tax reform package in the United States prompted the markets to begin factoring in faster than expected growth. The wage component of the January 2018 employment report showed an unexpected increase, sparking fears that core inflation may finally be set to rise above the U.S. Federal Reserve s 2% target level. As a result, the yield on the 10-year Treasury note which sat just above 2.40% at the end of November 2017 climbed as high as 2.94% in mid-february Yields subsequently movedlowerinmarch2018,butthe earlier spike was sufficient to depress the returns of interest rate-sensitive assets, including U.S. Treasuries, corporate bonds and municipal issues for the full 12-month period ended March 31, High-yield bonds performed somewhat better than investment-grade issues, reflecting their higher sensitivity to economic growth and below-average correlation with the direction of interest rates. While rising interest rates can eventually take a toll on high yield bonds, tightening typically needs to occur over a longer period before there is a meaningfully negative effect on market rate issuers ability to service their debt. The substantial decline in yield spreads that has taken place over the past two years has made high yield bonds more expensive, potentially dampening their upside potential. The direction of the U.S. Federal Reserve policy remained a key wild card for the U.S. market as the Period drew to a close. Specifically, investors remained focused on determining how many interest rate hikes may be on tap for the remainder of The presence of a new Chairman of the Board of Governors of the Federal Reserve System, Jerome Powell, has added some uncertainty. Mr. Powell gave his first public address to the House Financial Services Committee in February. His comments were optimistic, noting that some of the headwinds the U.S. economy faced in previous years have turned into tailwinds. Investors largely viewed this as a sign of continuity between Powell and his predecessor, Janet Yellen. Still, several factors are at work in determining the extent to which the U.S. Federal Reserve will raise interest rates. On one hand, benign inflation, the possibility of a trade war and increased market volatility could restrain the U.S. Federal Reserve from raising interest rates. Conversely, we believe the U.S. Federal Reserve would require very healthy economic conditions highlighted by faster growth, rising inflation and agreeable investor sentiment to tighten more aggressively. While rising wages are indeed somethingtowatch,wedonotbelieve that this trend is signaling an upward march in inflation. Generally, as long as higher wages are paired with productivity gains, corporate profit margins can expand and the markets can remain upbeat. We believe this would open the door for the U.S. Federal Reserve to continue raising interest rates gradually rather than tightening its policy more quickly in order to combat accelerating inflation. We therefore believe that bonds can perform reasonably well during the coming months as long as the economy remains in the sweet spot of slow, steady growth with moderate inflation. Bob Browne Chief Investment Officer Northern Trust

3 FIXED INCOME FUNDS TABLE OF CONTENTS 2 PORTFOLIO MANAGEMENT COMMENTARY 10 STATEMENTS OF ASSETS AND LIABILITIES 12 STATEMENTS OF OPERATIONS 14 STATEMENTS OF CHANGES IN NET ASSETS 16 FINANCIAL HIGHLIGHTS 24 SCHEDULES OF INVESTMENTS This report has been prepared for the general information of Northern Funds shareholders. It is not authorized for distribution to prospective investors unless accompanied or preceded by a current Northern Funds summary prospectus or prospectus, which contains more complete information about a fund s investment objectives, risks, fees and expenses. Investors are reminded to read a summary prospectus or prospectus carefully before investing or sending money. This report contains certain forward-looking statements about factors that may affect the performance of the funds in the future. These statements are based on Northern Funds management predictions and expectations concerning certain future events, such as performance of the economy as a whole and of specific industry sectors, changes in the levels of interest rates, the impact of developing world events, and other factors. Management believes these forward-looking statements to be reasonable, although they are inherently uncertain and difficult to predict. Actual events may cause adjustments in Northern Funds management strategies from those currently expected to be employed. Northern Funds are distributed by Northern Funds Distributors, LLC, Three Canal Plaza, Suite 100, Portland, Maine 04101, not affiliated with Northern Trust. 24 CORE BOND FUND Ticker Symbol: NOCBX 34 FIXED INCOME FUND Ticker Symbol: NOFIX 46 HIGH YIELD FIXED INCOME FUND Ticker Symbol: NHFIX 54 SHORT BOND FUND Ticker Symbol: BSBAX 64 SHORT-INTERMEDIATE U.S. GOVERNMENT FUND Ticker Symbol: NSIUX 67 TAX-ADVANTAGED ULTRA-SHORT FIXED INCOME FUND Ticker Symbol: NTAUX 86 ULTRA-SHORT FIXED INCOME FUND Ticker Symbol: NUSFX 101 U.S. GOVERNMENT FUND Ticker Symbol: NOUGX 104 NOTES TO THE FINANCIAL STATEMENTS 115 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 116 TAX INFORMATION 117 FUND EXPENSES 119 TRUSTEES AND OFFICERS 123 INVESTMENT CONSIDERATIONS 124 FOR MORE INFORMATION NOT FDIC INSURED May lose value / No bank guarantee NORTHERN FUNDS ANNUAL REPORT 1 FIXED INCOME FUNDS

4 FIXED INCOME FUNDS CORE BOND FUND* (UNAUDITED) PORTFOLIO MANAGEMENT COMMENTARY For the 12-month reporting period ended March 31, 2018, markets grappled with a rapidly changing landscape. In the United States, the U.S. Federal Reserve to remove monetary accommodation gradually by raising interest rates and reducing the size of its balance sheet. Uncertainty regarding U.S. fiscal policy was ultimately resolved with a U.S. tax reform package and a budget deal that increased government spending. The economic cycle while extended by historical measures nonetheless hit on all cylinders globally, and market performance reflected optimism that the boost from fiscal policy would prolong the expansion. The U.S. job market its post-crisis growth with the addition of 2.3 million positions over the 2017 period. The unemployment rate fell to a 16-year low of 4.1%, while gross domestic product growth averaged nearly 3%. However, core inflation rebounded. Higher-risk assets responded well to this set of circumstances before uncertainty regarding trade policy weighed on market sentiment late in the period. The Fund began the period with an overweight in higher-risk market segments and duration below that of the Fund s benchmark the Bloomberg Barclays U.S. Aggregate Bond Index. As the post-2016 U.S. election euphoria faded and market participants began to question the direction of U.S. policy, we pared back on risk slightly. We re-established an overweight in credit late in the summer 2017 to take advantage of the improved growth outlook and the potential for increased fiscal stimulus. This positioning performed very well into February 2018, when concerns about policy again reduced investor risk appetite. For the 12-month period ended March 31, 2018 the Fund returned 1.45%, outperforming the 1.20% return of its benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index. An overweight to credit added to the Fund s performance, as did security selection. Duration and positioning also provided a boost to the Fund s results, but the benefit was offset somewhat by effect of a yield curve rolldown. INVESTMENT PERFORMANCE PORTFOLIO MANAGERS AVERAGE ANNUAL RETURNS for periods ended March 31, 2018 TOTAL RETURN ONE YEAR FIVE YEAR TEN YEAR SINCE INCEPTION 03/29/01 CORE BOND FUND 1.45% 1.75% 4.08% 4.38% BLOOMBERG BARCLAYS U.S. AGGREGATE BOND INDEX Fund Performance reflects contractual expense reimbursements in effect. In their absence, performance would be reduced. Performance quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here. Performance data current to the most recent month-end is available at northerntrust.com/funds. *The Fund commenced operations on March 29, 2001 as a separate portfolio of Northern Institutional Funds (the Predecessor Fund ). On November 16, 2012, the Predecessor Fund was reorganized into the Fund, which was a new portfolio of Northern Funds with the same investment objective, strategies and policies as the Predecessor Fund. Performance information for the period prior to November 17, 2012 represents the performance of Class A shares of the Predecessor Fund. BRADLEY CAMDEN With Northern Trust since 2005 DANIEL J. PERSONETTE With Northern Trust since 1996 GROWTH OF A $10,000 INVESTMENT $25,000 $20,000 $15,000 $10,000 $5,000 3/29/01 $20,733 $21,029 3/31/18 The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Unlike the Index, the Fund s total returns are reduced by operating expenses, such as transaction costs and management fees. A direct investment in an Index is not possible. CORE BOND FUND BLOOMBERG BARCLAYS U.S. AGGREGATE BOND INDEX The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate and hybrid adjustable-rate mortgage pass-throughs), assetbacked securities, and commercial mortgage-backed securities. Information about Investment Considerations can be found on page 123. FIXED INCOME FUNDS 2 NORTHERN FUNDS ANNUAL REPORT

5 FIXED INCOME FUNDS FIXED INCOME FUND (UNAUDITED) PORTFOLIO MANAGEMENT COMMENTARY During the 12-month period ended March 31, 2018, markets grappled with a rapidly changing landscape. In the United States, the U.S. Federal Reserve to remove monetary accommodation gradually by raising interest rates and reducing the size of its balance sheet. Uncertainty regarding U.S. fiscal policy was ultimately resolved with a U.S. tax reform package and a budget deal that increased government spending. The economic cycle while extended by historical measures nonetheless hit on all cylinders globally, and market performance reflected optimism that the boost from fiscal policy would prolong the expansion. The U.S. job market its post-crisis growth with the addition of 2.3 million positions over the 2017 period. The unemployment rate fell to a 16-year low of 4.1%, while gross domestic product growth averaged nearly 3%. However, core inflation rebounded. Higher-risk assets responded well to this set of circumstances before uncertainty regarding trade policy weighed on market sentiment late in the period. The Fixed Income Fund began the period with an overweight in higher-risk market segments and duration below that of the Fund s benchmark the Bloomberg Barclays U.S. Aggregate Bond Index. As the post-2016 U.S. election euphoria faded and market participants began to question the direction of U.S. policy, we pared back on risk slightly. We re-established an overweight in credit by adding to the Fund s investment-grade and high-yield corporate bond holdings late in the summer 2016 to take advantage of the improved growth outlook and the potential for increased fiscal stimulus. This positioning performed very well into February 2018, when concerns about policy again reduced investor risk appetite. For the 12-month period ended March 31, 2018 the Fund returned 1.38% and outperformed the 1.20% return of its benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index. An overweight to credit added to the Fund s performance, as did security selection in high yield. Duration and positioning also provided a boost to the Fund s results, but the benefit was offset somewhat by effect of a yield curve rolldown. INVESTMENT PERFORMANCE PORTFOLIO MANAGERS AVERAGE ANNUAL RETURNS for periods ended March 31, 2018 TOTAL RETURN ONE YEAR FIVE YEAR TEN YEAR SINCE INCEPTION 04/01/94 FIXED INCOME FUND 1.38% 2.01% 3.95% 4.97% BLOOMBERG BARCLAYS U.S. AGGREGATE BOND INDEX Fund Performance reflects contractual expense reimbursements in effect. In their absence, performance would be reduced. Performance quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here. Performance data current to the most recent month-end is available at northerntrust.com/funds. BRADLEY CAMDEN With Northern Trust since 2005 DANIEL J. PERSONETTE With Northern Trust since 1996 GROWTH OF A $10,000 INVESTMENT $38,000 $34,000 $30,000 $26,000 $22,000 $18,000 $14,000 $10,000 $6,000 4/1/94 $32,037 $35,079 3/31/18 The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Unlike the Index, the Fund s total returns are reduced by operating expenses, such as transaction costs and management fees. A direct investment in an Index is not possible. FIXED INCOME FUND BLOOMBERG BARCLAYS U.S. AGGREGATE BOND INDEX The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate and hybrid adjustable-rate mortgage pass-throughs), assetbacked securities, and commercial mortgage-backed securities. Information about Investment Considerations can be found on page 123. NORTHERN FUNDS ANNUAL REPORT 3 FIXED INCOME FUNDS

6 FIXED INCOME FUNDS HIGH YIELD FIXED INCOME FUND (UNAUDITED) PORTFOLIO MANAGEMENT COMMENTARY The 12-month period ended March 31, 2018 was characterized by ongoing economic growth and strong corporate earnings. The economic environment was supported throughout by the U.S. federal administration efforts to ease regulatory burdens and by the enactment in December 2017 of a more competitive U.S. tax regime. After an extended period of minimal volatility, financial markets experienced a difficult February and March of 2018, as investors became concerned about rising interest rates and the U.S. federal administration threatened tariffs as a means to negotiate more favorable trade agreements. Lastly, negative headlines surrounding a number of large technology companies pressured markets. While returns moderated late in the period, underlying fundamentals remained supportive. The High Yield Fixed Income Fund provided a total return of 4.32% for the 12-month reporting period, as compared to its benchmark the Bloomberg Barclays U.S. Corp High Yield 2% Issuer Capped Index return of 3.78%. Performance within the high yield bond market was led during the period by the lowest-rated issuers. To illustrate, bonds rated in the Ca-D range generated a 6.80% return and CCC bonds returned 5.78%, while those rated BB and B returned 3.47% and 3.29%, respectively. Throughout the period, the Fund carried a material overweight to CCC-rated securities along with a modest overweight to B-rated securities, funded through a material underweight to BB securities. This positioning allowed the Fund to take advantage of an improving economy and strong corporate earnings. In addition, an underweight to more interest rate-sensitive BB-rated securities benefited performance as the U.S. Federal Reserve increased its benchmark rate and began to shrink its bond holdings over the period. While an overweight position in energy-related issues detracted from performance over the first three months of the period as energy prices fell, these issues outperformed over the remainder of the period as the price of oil strengthened. Performance also benefited from overweight positions in metals and financial issuers. Corporate earnings growth and a low default rate continue to support the relative value of the high yield market. INVESTMENT PERFORMANCE PORTFOLIO MANAGERS AVERAGE ANNUAL RETURNS for periods ended March 31, 2018 TOTAL RETURN ONE YEAR FIVE YEAR TEN YEAR SINCE INCEPTION 12/31/98 HIGH YIELD FIXED INCOME FUND 4.32% 4.18% 6.73% 5.86% BLOOMBERG BARCLAYS U.S. CORP HIGH YIELD 2% ISSUER CAPPED INDEX Fund Performance reflects contractual expense reimbursements in effect. In their absence, performance would be reduced. Performance quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here. Performance data current to the most recent month-end is available at northerntrust.com/funds. RICHARD J. INZUNZA With Northern Trust since 2007 ERIC WILLIAMS With Northern Trust since 2008 BRADLEY CAMDEN With Northern Trust since 2005 GROWTH OF A $10,000 INVESTMENT $38,000 $34,000 $30,000 $26,000 $22,000 $18,000 $14,000 $10,000 $6,000 12/31/98 $29,903 $36,489 3/31/18 The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Unlike the Index, the Fund s total returns are reduced by operating expenses, such as transaction costs and management fees. A direct investment in an Index is not possible. HIGH YIELD FIXED INCOME FUND BLOOMBERG BARCLAYS U.S. CORP HIGH YIELD 2% ISSUER CAPPED INDEX The Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index is an unmanaged index that measures the market of U.S. dollar-denominated, non-investment grade, fixed rate, taxable corporate bonds. It is a version of the Bloomberg Barclays High Yield Corporate Bond Index except that it limits its exposure of each issuer to 2% of the total market value and redistributes any excess market value Index-wide on a pro-rata basis. The Fund invests in below investment-grade debt obligations, commonly known as junk bonds. While offering higher current yields, these securities generally are considered speculative and are subject to greater risks than higher-rated bonds. Information about Investment Considerations can be found on page 123. FIXED INCOME FUNDS 4 NORTHERN FUNDS ANNUAL REPORT

7 FIXED INCOME FUNDS SHORT BOND FUND* (UNAUDITED) PORTFOLIO MANAGEMENT COMMENTARY During the 12-month period ended March 31, 2018, markets grappled with a rapidly changing landscape. In the United States, the U.S. Federal Reserve to remove monetary accommodation gradually by raising interest rates and reducing the size of its balance sheet. Uncertainty regarding U.S. fiscal policy was ultimately resolved with a U.S. tax reform package and a budget deal that increased government spending. The economic cycle while extended by historical measures nonetheless hit on all cylinders globally, and market performance reflected optimism that the boost from fiscal policy would prolong the expansion. The U.S. job market its post-crisis growth with the addition of 2.3 million positions over the 2017 period. The unemployment rate fell to a 16-year low of 4.1%, while gross domestic product growth averaged nearly 3%. However, core inflation rebounded. Higher-risk assets responded well to this set of circumstances before uncertainty regarding trade policy weighed on market sentiment late in the period. The Short Bond Fund began the period with an overweight in higher-risk market segments and duration below that of the Fund s benchmark, the Bloomberg Barclays 1-3 Year U.S. Government/Credit Index. As the post-2016 U.S. election euphoria faded and market participants began to question the direction of U.S. policy, we pared back on risk slightly. We re-established an overweight in credit by adding to the Fund s investment-grade and high-yield corporate bond holdings late in the summer 2017 to take advantage of the improved growth outlook and the potential for increased fiscal stimulus. This positioning performed very well into February 2018, when concerns about policy again reduced investor risk appetite. For the 12-month period ended March 31, 2018 the Fund returned 0.45% and outperformed the 0.24% return of its benchmark, the Bloomberg Barclays 1-3 Year U.S. Government/Credit Index. An overweight to credit added to the Fund s performance, as did security selection in high yield. Duration and positioning also provided a boost to the Fund s results, but the benefit was offset somewhat by effect of a yield curve rolldown. INVESTMENT PERFORMANCE PORTFOLIO MANAGERS AVERAGE ANNUAL RETURNS for periods ended March 31, 2018 TOTAL RETURN ONE YEAR FIVE YEAR TEN YEAR SINCE INCEPTION 01/11/93 SHORT BOND FUND 0.45% 0.77% 1.96% 3.86% BLOOMBERG BARCLAYS 1-3 YEAR U.S. GOVERNMENT/CREDIT INDEX Fund Performance reflects contractual expense reimbursements in effect. In their absence, performance would be reduced. Performance quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here. Performance data current to the most recent month-end is available at northerntrust.com/funds. *The Fund commenced operations on January 11, 1993 as a separate portfolio of Northern Institutional Funds (the Predecessor Fund ). On November 16, 2012, the Predecessor Fund was reorganized into the Fund, which was a new portfolio of Northern Funds with the same investment objective, strategies and policies as the Predecessor Fund. Performance information for the period prior to November 17, 2012, represents the performance of Class A shares of the Predecessor Fund. BRADLEY CAMDEN With Northern Trust since 2005 MICHAEL T. DOYLE With Northern Trust since 1999 GROWTH OF A $10,000 INVESTMENT $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 1/11/93 $25,970 $25,782 3/31/18 The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Unlike the Index, the Fund s total returns are reduced by operating expenses, such as transaction costs and management fees. A direct investment in an Index is not possible. SHORT BOND FUND BLOOMBERG BARCLAYS 1-3 YEAR U.S. GOVERNMENT/CREDIT INDEX The Bloomberg Barclays 1-3 Year U.S. Government/Credit Index is an unmanaged index of securities issued by the U.S. government and corporate bonds with maturities of one to three years. Information about Investment Considerations can be found on page 123. NORTHERN FUNDS ANNUAL REPORT 5 FIXED INCOME FUNDS

8 FIXED INCOME FUNDS SHORT-INTERMEDIATE U.S. GOVERNMENT FUND (UNAUDITED) PORTFOLIO MANAGEMENT COMMENTARY During the 12-month period ended March 31, 2018, markets grappled with a rapidly changing landscape. In the United States, the U.S. Federal Reserve to remove monetary accommodation gradually by raising interest rates and reducing the size of its balance sheet. Uncertainty regarding U.S. fiscal policy was ultimately resolved with a U.S. tax reform package and a budget deal that increased government spending. The economic cycle while extended by historical measures nonetheless hit on all cylinders globally, and market performance reflected optimism that the boost from fiscal policy would prolong the expansion. The U.S. job market its post-crisis growth with the addition of 2.3 million positions over the 2017 Period. The unemployment rate fell to a 16-year low of 4.1%, while gross domestic product growth averaged nearly 3%. However, core inflation rebounded. Higher-risk assets responded well to this set of circumstances before uncertainty regarding trade policy weighed on market sentiment late in the period. The U.S. Treasury yield curve steepened, as the two-year yield climbed 100 basis points, from 1.27% to 2.27%, while the 10-year yield rose 35 basis points, from 2.39% to 2.74%. Break-even rates on 10-year Treasury Inflation Protected Securities rose from 1.97% to 2.05%, a sign of increasing inflation expectations. The Short-Intermediate U.S. Government Fund returned -0.55% for the period, underperforming the -0.09% return of its benchmark, the Bloomberg Barclays 1-5 Year U.S. Government Index for the same period. An overweight in mortgage-backed securities ( MBS ) was a key factor in the Fund s underperformance. Duration and yield curve positioning contributed positively to results, nearly offsetting the effect of the overweight in MBS. Conversely, security selection was a marginal detractor. At the close of the period, we were keeping a watchful eye to determine whether the rhetoric over trade could turn into a substantive drag on growth. In addition, we were closely monitoring the U.S. Federal Reserve s interest rate policy and the outlook for central bank actions in Europe and Japan. INVESTMENT PERFORMANCE PORTFOLIO MANAGER AVERAGE ANNUAL RETURNS for periods ended March 31, 2018 TOTAL RETURN ONE YEAR FIVE YEAR TEN YEAR SINCE INCEPTION 10/01/99 SHORT-INTERMEDIATE U.S. GOVERNMENT FUND 0.55% 0.05% 1.33% 2.82% BLOOMBERG BARCLAYS 1-5 YEAR U.S. GOVERNMENT INDEX Fund Performance reflects contractual expense reimbursements in effect. In their absence, performance would be reduced. Performance quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here. Performance data current to the most recent month-end is available at northerntrust.com/funds. MICHAEL R. CHICO With Northern Trust since 2005 GROWTH OF A $10,000 INVESTMENT $20,000 $18,000 $16,000 $14,000 $12,000 $10,000 $8,000 10/1/99 $16,726 $18,451 3/31/18 The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Unlike the Index, the Fund s total returns are reduced by operating expenses, such as transaction costs and management fees. A direct investment in an Index is not possible. SHORT-INTERMEDIATE U.S. GOVERNMENT FUND BLOOMBERG BARCLAYS 1-5 YEAR U.S. GOVERNMENT INDEX The Bloomberg Barclays 1-5 Year U.S. Government Index is an unmanaged index of debt securities including all public obligations of the U.S. Treasury and all publicly issued debt of U.S. government agencies with maturities of one to five years. Unlike U.S. Treasury bonds and bills, the principal value and investment return of the Fund are neither guaranteed nor insured by the U.S. Government. Information about Investment Considerations can be found on page 123. FIXED INCOME FUNDS 6 NORTHERN FUNDS ANNUAL REPORT

9 FIXED INCOME FUNDS TAX-ADVANTAGED ULTRA-SHORT FIXED INCOME FUND (UNAUDITED) PORTFOLIO MANAGEMENT COMMENTARY Rising interest rates, U.S. policy changes and financial market volatility made headlines during the 12-month period ended March 31, The U.S. Federal Reserve raised short-term interest rates three times, with the federal funds rate ending at %. These moves were well telegraphed and anticipated by the market given an environment of strong employment and low inflation. Investor speculation regarding the impact of changes to the Affordable Care Act, alterations to personal and corporate U.S. tax rates, and corporations repatriation of cash added to market volatility. Short-term U.S. Treasury rates were relatively stable until September 2017, before rising dramatically through the end of Taxable supply was again robust as issuers took advantage of low interest rates and tighter credit spreads. Municipal supply declined compared with the prior period, which kept municipal rates stable until drastically increased issuance in December 2017 caused yields to rise. Yields subsequently reversed course and moved lower in 2018 as issuance slowed and investor demand rose. The Tax-Advantaged Ultra-Short Fixed Income Fund returned 0.60% for the annual 12-month period ended March 31, 2018, in line with the 0.63% return of the blended benchmark. The Fund s net asset value ( NAV ) was relatively stable until December 2017, when a large increase in municipal bond issuance pressured prices. As of March 31, 2018, the Fund s NAV ultimately finished at $10.09 after starting the period at $ The Fund to purchase both taxable and tax-exempt bonds. The tax-advantaged strategy allows the Fund to have a preference for tax-exempt income but with the flexibility to own taxable issues if they offer higher after-tax yields. In both markets, we preferred high quality one-year fixed-rate and three-year floating-rate bonds, as they added both stability and liquidity to the Fund. We maintained an average portfolio credit quality of Aa3/AA. We reduced the Fund s duration over the period to mitigate the effect of rising interest rates. However, higher interest rates also mean that investors willing to accept some price volatility have the potential to receive additional income and total return on a tax-efficient basis. INVESTMENT PERFORMANCE PORTFOLIO MANAGERS AVERAGE ANNUAL RETURNS for periods ended March 31, 2018 TOTAL RETURN ONE YEAR THREE YEAR FIVE YEAR SINCE INCEPTION 06/18/09 TAX-ADVANTAGED ULTRA-SHORT FIXED INCOME FUND 0.60% 0.65% 0.62% 0.95% ICE 75% BOFA MERRILL LYNCH 6-12 MONTH MUNICIPAL SECURITIES INDEX AND 25% BOFA MERRILL LYNCH 1-3 YEAR U.S. GENERAL OBLIGATION MUNICIPAL SECURITIES INDEX ICE BOFA MERRILL LYNCH 6-12 MONTH MUNICIPAL SECURITIES INDEX ICE BOFA MERRILL LYNCH 1-3 YEAR US GENERAL OBLIGATION MUNICIPAL SECURITIES INDEX Fund Performance reflects contractual expense reimbursements in effect. In their absence, performance would be reduced. Performance quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here. Performance data current to the most recent month-end is available at northerntrust.com/funds. PATRICK D. QUINN With Northern Trust since 1985 JASON R. GOOKIN With Northern Trust since 2006 GROWTH OF A $10,000 INVESTMENT $12,000 $11,000 $10,000 $9,000 6/18/09 $10,865 $10,656 $10,501 $11,140 3/31/18 The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Unlike the Indices, the Fund s total returns are reduced by operating expenses, such as transaction costs and management fees. A direct investment in an Index is not possible. TAX-ADVANTAGED ULTRA-SHORT FIXED INCOME FUND ICE BOFA MERRILL LYNCH 6-12 MONTH MUNICIPAL SECURITIES INDEX ICE 75% BOFA MERRILL LYNCH 6-12 MONTH MUNICIPAL SECURITIES INDEX AND 25% BOFA MERRILL LYNCH 1-3 YEAR US GENERAL OBLIGATION MUNICIPAL SECURITIES INDEX ICE BOFA MERRILL LYNCH 1-3 YEAR US GENERAL OBLIGATION MUNICIPAL SECURITIES INDEX The ICE BofA Merrill Lynch 6-12 Month Municipal Securities Index tracks the performance of U.S. dollardenominated, investment grade, tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market. Qualifying securities must have six months to one year remaining term to final maturity, a fixed coupon schedule and an investment grade rating (based on an average of Moody s, S&P and Fitch). The ICE BofA Merrill Lynch 1-3 Year US General Obligation Municipal Securities Index tracks the performance of U.S. dollar denominated, investment grade, tax-exempt, general obligations publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market. Qualifying securities must have one to three years remaining term to maturity, a fixed coupon schedule and an investment grade rating (based on an average of Moody s, S&P and Fitch). Information about Investment Considerations can be found on page 123. NORTHERN FUNDS ANNUAL REPORT 7 FIXED INCOME FUNDS

10 FIXED INCOME FUNDS ULTRA-SHORT FIXED INCOME FUND (UNAUDITED) PORTFOLIO MANAGEMENT COMMENTARY The U.S. Federal Reserve enacted three quarter-point interest rate increases during the 12-month period ended March 31, In addition, the U.S. Federal Reserve announced the start of its much anticipated balance sheet reduction at its September 2017 meeting. Although the announcement was expected, the policy is hugely important and likely to shape the fixed-income landscape for years to come. There was also a change in U.S. Federal Reserve leadership, as Jerome Powell replaced Janet Yellen as Fed chair. The transition has been smooth thus far, with limited market implications. Political and geopolitical risk surfaced throughout the period. The U.S. federal administration dominated headlines, on many occasions affecting market performance. On the geopolitical front, North Korea took center stage for a time before tensions waned amid talks about an upcoming meeting between the country s two leaders. Economic sentiment was fairly positive in spite of policy and geopolitical news. Markets and investor risk appetite were boosted by the passage of large business and personal U.S. tax cuts as well as a budget agreement that increased spending. The improved sentiment was evident in economic data, as the United States experienced several quarters of 3%+ growth and unemployment that to decline. U.S. Treasury yields moved substantially higher in an environment of rising interest rates and improving sentiment. Yields of one-, twoand three-year notes rose 1.07, 1.02, and 0.89 percentage points, respectively. Credit spreads tightened throughout most of the period, but much of the gain was reversed in the first quarter of 2018 as corporations with offshore bond holdings sold securities to realign their capital structures to the new U.S. tax law. The Ultra-Short Fixed Income Fund returned 0.96%, versus 0.66% for its benchmark ICE BofA Merrill Lynch 1-Year U.S. Treasury Note Index for the 12-month period ended March 31, The Fund outperformed its benchmark due to its overweight position in higher-yielding market segments and its slightly shorter duration. INVESTMENT PERFORMANCE PORTFOLIO MANAGERS AVERAGE ANNUAL RETURNS for periods ended March 31, 2018 TOTAL RETURN ONE YEAR THREE YEAR FIVE YEAR SINCE INCEPTION 6/18/09 ULTRA-SHORT FIXED INCOME FUND 0.96% 1.03% 0.93% 1.27% ICE BOFA MERRILL LYNCH 1-YEAR U.S. TREASURY NOTE INDEX Fund Performance reflects contractual expense reimbursements in effect. In their absence, performance would be reduced. Performance quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here. Performance data current to the most recent month-end is available at northerntrust.com/funds. CHRISTI FLETCHER With Northern Trust since 2010 MORTEN OLSEN With Northern Trust since 2009 GROWTH OF A $10,000 INVESTMENT $11,500 $11,000 $10,500 $10,000 $9,500 6/18/09 $11,173 $10,439 3/31/18 The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Unlike the Index, the Fund s total returns are reduced by operating expenses, such as transaction costs and management fees. A direct investment in an Index is not possible. ULTRA-SHORT FIXED INCOME FUND ICE BOFA MERRILL LYNCH 1-YEAR U.S. TREASURY NOTE INDEX ICE BofA Merrill Lynch 1-Year U.S. Treasury Note Index is composed of a single issue: the outstanding Treasury note that matures closest to, but not beyond, one year from each monthly rebalancing date. Information about Investment Considerations can be found on page 123. FIXED INCOME FUNDS 8 NORTHERN FUNDS ANNUAL REPORT

11 FIXED INCOME FUNDS U.S. GOVERNMENT FUND (UNAUDITED) PORTFOLIO MANAGEMENT COMMENTARY Markets grappled with a rapidly changing landscape during the 12-month period ended March 31, In the United States, the U.S. Federal Reserve to remove monetary accommodation gradually by raising interest rates and reducing the size of its balance sheet. Uncertainty regarding U.S. fiscal policy was ultimately resolved with a U.S. tax reform package and a budget deal that increased government spending. The economic cycle while extended by historical measures nonetheless hit on all cylinders globally, and market performance reflected optimism that the boost from fiscal policy would prolong the expansion. The U.S. job market its post-crisis growth with the addition of 2.3 million positions over the period. The unemployment rate fell to a 16-year low of 4.1%, while gross domestic product growth averaged nearly 3%. However, core inflation rebounded. Higher-risk assets responded well to this set of circumstances before uncertainty regarding trade policy weighed on market sentiment late in the period. The U.S. Treasury yield curve steepened, as the two-year yield climbed 100 basis points, from 1.27% to 2.27%, while the 10-year yield rose 35 basis points, from 2.39% to 2.74%. Break-even rates on 10-year Treasury Inflation Protected Securities rose from 1.97% to 2.05%, a sign of increasing inflation expectations. The U.S. Government Fund returned -0.62% for the 12-month period ended March 31, 2018, underperforming the -0.14% return of its benchmark, the Bloomberg Barclays Intermediate U.S. Government Bond Index for the same period. An overweight in mortgage-backed securities ( MBS ) was a key factor in the Fund s underperformance. Duration and yield curve positioning contributed positively to results, nearly offsetting the effect of the overweight in MBS. Conversely, security selection was a marginal detractor. At the close of the period, we were keeping a watchful eye to determine whether the rhetoric over trade could turn into a substantive drag on growth. In addition, we were closely monitoring the U.S. Federal Reserve s interest rate policy and the outlook for central bank actions in Europe and Japan. INVESTMENT PERFORMANCE PORTFOLIO MANAGER AVERAGE ANNUAL RETURNS for periods ended March 31, 2018 TOTAL RETURN ONE YEAR FIVE YEAR TEN YEAR SINCE INCEPTION 04/01/94 U.S. GOVERNMENT FUND 0.62% 0.16% 1.91% 3.88% BLOOMBERG BARCLAYS INTERMEDIATE U.S. GOVERNMENT BOND INDEX Fund Performance reflects contractual expense reimbursements in effect. In their absence, performance would be reduced. Performance quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown here. Performance data current to the most recent month-end is available at northerntrust.com/funds. MICHAEL R. CHICO With Northern Trust since 2005 GROWTH OF A $10,000 INVESTMENT $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 4/1/94 $24,912 $28,552 3/31/18 The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Unlike the Index, the Fund s total returns are reduced by operating expenses, such as transaction costs and management fees. A direct investment in an Index is not possible. U.S. GOVERNMENT FUND BLOOMBERG BARCLAYS INTERMEDIATE U.S. GOVERNMENT BOND INDEX The Bloomberg Barclays Intermediate U.S. Government Bond Index is an unmanaged index of debt securities including all public obligations of the U.S. Treasury and all publicly issued debt of U.S. government agencies with maturities of up to 10 years. Unlike U.S. Treasury bonds and bills, the principal value and investment return of the Fund are neither guaranteed nor insured by the U.S. Government. Information about Investment Considerations can be found on page 123. NORTHERN FUNDS ANNUAL REPORT 9 FIXED INCOME FUNDS

12 FIXED INCOME FUNDS STATEMENTS OF ASSETS AND LIABILITIES Amounts in thousands, except per share data CORE BOND FUND FIXED INCOME FUND ASSETS: Investments, at value $261,983 $1,179,212 Investments in affiliates, at value 2,590 2,598 Foreign currencies, at value (cost $46) Interest income receivable 1,511 9,112 Dividend income receivable Receivable for foreign tax reclaims 14 2 Receivable for securities sold Receivable for fund shares sold Receivable from investment adviser 2 5 Prepaid and other assets 2 9 Total Assets 267,221 1,192,413 LIABILITIES: Payable for securities purchased Payable for when-issued securities Payable for fund shares redeemed Distributions payable to shareholders Payable to affiliates: Management fees Custody fees 5 7 Shareholder servicing fees 1 32 Transfer agent fees 1 3 Trustee fees 4 14 Accrued other liabilities Total Liabilities 386 2,082 Net Assets $266,835 $1,190,331 ANALYSIS OF NET ASSETS: Capital stock $275,372 $1,224,812 Accumulated undistributed net investment income (loss) (109) (566) Accumulated undistributed net realized loss (5,826) (21,883) Net unrealized depreciation (2,602) (12,032) Net Assets $266,835 $1,190,331 Shares Outstanding ($.0001 par value, unlimited authorization) 26, ,704 Net Asset Value, Redemption and Offering Price Per Share $10.02 $9.94 Investments, at cost $264,500 $1,190,812 Investments in affiliates, at cost 2,590 2,598 FIXED INCOME FUNDS 10 NORTHERN FUNDS ANNUAL REPORT

13 MARCH 31, 2018 HIGH YIELD FIXED INCOME FUND SHORT BOND FUND SHORT- INTERMEDIATE U.S. GOVERNMENT FUND TAX-ADVANTAGED ULTRA-SHORT FIXED INCOME FUND ULTRA-SHORT FIXED INCOME FUND U.S. GOVERNMENT FUND $3,435,334 $485,824 $114,551 $3,860,928 $2,563,276 $22,201 54, ,023 21,078 29,485 1, ,730 2, ,996 9, ,770 2,393 2, ,662 6, ,599, , ,879 3,923,677 2,608,341 24,103 11,924 1,500 11,432 23,900 5,858 9,500 2,400 1,121 3,367 2, ,404 3, , ,925 3,825 5,962 14,801 18,043 1,176 $3,556,517 $487,524 $113,917 $3,908,876 $2,590,298 $22,927 $3,971,324 $502,303 $119,592 $3,924,715 $2,601,395 $24,297 (275) (151) (222) (8) 91 (369,080) (10,044) (4,508) (435) (188) (1,229) (45,452) (4,584) (1,167) (15,182) (10,901) (232) $3,556,517 $487,524 $113,917 $3,908,876 $2,590,298 $22, ,880 26,212 11, , ,294 2,430 $6.72 $18.60 $9.61 $10.09 $10.15 $9.43 $3,480,790 $490,408 $115,474 $3,876,110 $2,574,177 $22,405 54, ,023 21,078 29,485 1,821 NORTHERN FUNDS ANNUAL REPORT 11 FIXED INCOME FUNDS

14 FIXED INCOME FUNDS STATEMENTS OF OPERATIONS Amounts in thousands CORE BOND FUND FIXED INCOME FUND HIGH YIELD FIXED INCOME FUND INVESTMENT INCOME: Interest Income $7,234 $39,593 $277,858 Dividend income 1,556 Dividend income from investments in affiliates ,209 Total Investment Income 7,342 40, ,623 EXPENSES: Management fees 962 5,078 31,582 Custody fees Transfer agent fees Blue sky fees SEC fees Printing fees Audit fees Legal fees Shareholder servicing fees Trustee fees Interest expense 15 Other Total Expenses 1,157 5,612 33,468 Less expenses reimbursed by investment adviser (129) (283) (364) Net Expenses 1,028 5,329 33,104 Net Investment Income 6,314 34, ,519 NET REALIZED AND UNREALIZED GAINS (LOSSES): Net realized gains (losses) on: Investments (1,008) (1,673) 54,294 Futures contracts Net changes in unrealized appreciation (depreciation) on: Investments (1,535) (15,119) (119,151) Futures contracts (68) (491) Foreign currency translations 2 Net Losses (2,576) (17,103) (64,855) Net Increase (Decrease) in Net Assets Resulting from Operations $3,738 $17,646 $182,664 FIXED INCOME FUNDS 12 NORTHERN FUNDS ANNUAL REPORT

15 FOR THE FISCAL YEAR ENDED MARCH 31, 2018 SHORT BOND FUND SHORT- INTERMEDIATE U.S. GOVERNMENT FUND TAX-ADVANTAGED ULTRA-SHORT FIXED INCOME FUND ULTRA-SHORT FIXED INCOME FUND U.S. GOVERNMENT FUND $10,893 $1,984 $48,475 $37,872 $ ,975 2,076 48,920 38, , ,756 4, , ,071 5, (134) (112) (185) (254) (100) 2, ,886 5, ,951 1,580 39,034 32, (1,826) (1,642) (277) 876 (285) (65) (4,733) (774) (15,660) (13,477) (203) (10) (239) (27) (6,634) (2,233) (15,937) (12,601) (464) $2,317 $(653) $23,097 $20,179 $(136) NORTHERN FUNDS ANNUAL REPORT 13 FIXED INCOME FUNDS

16 FIXED INCOME FUNDS STATEMENTS OF CHANGES IN NET ASSETS CORE BOND FUND FIXED INCOME FUND HIGH YIELD FIXED INCOME FUND Amounts in thousands OPERATIONS: Net investment income $6,314 $4,987 $34,749 $31,979 $247,519 $289,676 $8,951 $7,146 Net realized gains (losses) (973) (2,342) (1,493) (5,514) 54,294 80,305 (1,891) (218) Net change in unrealized appreciation (depreciation) (1,603) (2,568) (15,610) (7,106) (119,149) 230,137 (4,743) 563 Net Increase (Decrease) in Net Assets Resulting from Operations 3, ,646 19, , ,118 2,317 7,491 CAPITAL SHARE TRANSACTIONS: Net increase (decrease) in net assets resulting from capital share transactions 10,052 20,464 29,558 (156,397) (810,690) (1,003,548) (281) (66,267) Net Increase (Decrease) in Net Assets Resulting from Capital Share Transactions 10,052 20,464 29,558 (156,397) (810,690) (1,003,548) (281) (66,267) DISTRIBUTIONS PAID: From net investment income (6,906) (5,625) (37,383) (35,089) (247,456) (288,997) (8,979) (7,407) From net realized gains (1,783) Total Distributions Paid (6,906) (7,408) (37,383) (35,089) (247,456) (288,997) (8,979) (7,407) Total Increase (Decrease) in Net Assets 6,884 13,133 9,821 (172,127) (875,482) (692,427) (6,943) (66,183) NET ASSETS: Beginning of year 259, ,818 1,180,510 1,352,637 4,431,999 5,124, , ,650 End of year $266,835 $259,951 $1,190,331 $1,180,510 $3,556,517 $4,431,999 $487,524 $494,467 Accumulated Undistributed Net Investment Income (Loss) $(109) $(138) $(566) $(889) $(275) $(338) $(151) $(203) SHORT BOND FUND FIXED INCOME FUNDS 14 NORTHERN FUNDS ANNUAL REPORT

17 FOR THE FISCAL YEARS ENDED MARCH 31, SHORT- INTERMEDIATE U.S. GOVERNMENT FUND TAX-ADVANTAGED ULTRA-SHORT FIXED INCOME FUND ULTRA-SHORT FIXED INCOME FUND U.S. GOVERNMENT FUND $1,580 $1,103 $39,034 $27,761 $32,780 $20,546 $328 $239 (1,220) (1,217) (277) 1, ,892 (234) (330) (1,013) (942) (15,660) 912 (13,477) 3,394 (230) (242) (653) (1,056) 23,097 30,172 20,179 25,832 (136) (333) (16,439) (31,154) 380, , , ,869 (582) (1,201) (16,439) (31,154) 380, , , ,869 (582) (1,201) (1,803) (1,340) (39,035) (27,761) (32,778) (20,543) (368) (279) (150) (1,081) (1,803) (1,340) (39,185) (27,761) (33,859) (20,543) (368) (279) (18,895) (33,550) 364, , , ,158 (1,086) (1,813) 132, ,362 3,544,536 3,370,160 2,207,740 1,542,582 24,013 25,826 $113,917 $132,812 $3,908,876 $3,544,536 $2,590,298 $2,207,740 $22,927 $24,013 $ $ $(222) $(221) $(8) $(10) $91 $91 NORTHERN FUNDS ANNUAL REPORT 15 FIXED INCOME FUNDS

18 FIXED INCOME FUNDS FINANCIAL HIGHLIGHTS CORE BOND FUND Selected per share data Net Asset Value, Beginning of Year $10.15 $10.40 $10.62 $10.27 $10.55 INCOME (LOSS) FROM INVESTMENT OPERATIONS: Net investment income Net realized and unrealized gains (losses) (0.11) (0.15) (0.10) 0.42 (0.26) Total from Investment Operations (0.02) LESS DISTRIBUTIONS PAID: From net investment income (0.28) (0.22) (0.22) (0.21) (0.25) From net realized gains (0.07) (0.10) (0.06) (0.01) Total Distributions Paid (0.28) (0.29) (0.32) (0.27) (0.26) Net Asset Value, End of Year $10.02 $10.15 $10.40 $10.62 $10.27 Total Return (1) 1.45% 0.36% 1.00% 6.04% 0.02% SUPPLEMENTAL DATA AND RATIOS: Net assets, in thousands, end of year $266,835 $259,951 $246,818 $223,549 $104,195 Ratio to average net assets of: Expenses, net of reimbursements and credits (2) 0.41% 0.40% 0.41% 0.40% 0.40% Expenses, before reimbursements and credits 0.46% 0.46% 0.45% 0.53% 0.84% Net investment income, net of reimbursements and credits (2) 2.49% 1.87% 1.92% 1.86% 2.32% Net investment income, before reimbursements and credits 2.44% 1.81% 1.88% 1.73% 1.88% Portfolio Turnover Rate % % % % 1,163.54% (1) (2) Assumes investment at net asset value at the beginning of the year, reinvestment of all dividends and distributions, and a complete redemption of the investment at net asset value at the end of the year. The net expenses and net investment income ratios include additional reimbursements of management or advisory fees, as applicable, incurred in connection with the investment of uninvested cash in affiliated money market funds approximately $18,000, $57,000, $32,000, $5,000 and $5,000, which represent lessthan 0.01, represent 0.02, less than 0.01, and 0.01 percent of average net assets for the fiscal years ended March 31, 2018, 2017, 2016, 2015 and 2014 respectively. Absent the additional reimbursements, net investment income and reimbursements would have been decreased and net expenses would havebeen increased by a corresponding amount. FIXED INCOME FUNDS 16 NORTHERN FUNDS ANNUAL REPORT