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International Fund —
International stocks finish the quarter down
2nd Quarter, 2016
"Given market conditions, we have focused our additions to the portfolio on high quality, idiosyncratic situations that are not dependent on a hypothetical global recovery to deliver superior returns. "
– Northern Cross, LLC

In a continued environment of low rates and weak global economic activity that has penalized businesses dependent on global growth, the Harbor International Fund lost ground in the second quarter of 2016 and underperformed its benchmark.
The Fund returned -1.64% for the quarter, trailing its benchmark, the MSCI EAFE (ND) Index, which returned -1.46%. The benchmark is a measure of equities in developed markets outside the United States. The Fund’s relative underperformance was due mostly to stock selection and an overweight allocation in the Consumer Discretionary sector. Stock selection in Energy and Financials detracted as well. The Fund was helped by overweights in Health Care and Consumer Staples, as well as stock selection in both of those sectors.
Key detractors during the period included the British retail and commercial bank Lloyds Banking Group and the American casino and resort company Las Vegas Sands. The Fund’s top contributors relative to the benchmark included U.K. bank Standard Chartered, Wynn Resorts and Barrick Gold.
Northern Cross’s comments were made in a July, 2016 report. Highlights adapted from the report appear below. All comments relate to the quarter ended June 30, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through June 30, 2016.

Interview Highlights

Brexit Triggers U.K. Stock Reevaluation
The portfolio currently has an underweight in U.K. stocks relative to the benchmark. Leading up to the E.U. referendum vote, the Manager evaluated the Fund’s U.K. positions and felt that one of the initial implications of Brexit would be a weaker British Pound, which could benefit several of the global, export-oriented companies in that market. These types of companies comprise about three-quarters of the Fund’s U.K. allocation; examples include Rolls-Royce, Diageo, and Reckitt Benckiser, all of which derive a large portion of their revenues from outside the U.K. and outside of Europe. The Manager believes that the Brexit will likely impact the U.K. economy to the downside but that the weakened British Pound and easy-money policy of the Bank of England should shelter it from a recession.
Capitalizing on Idiosyncratic Themes
We have invested a substantial amount of time researching themes that are not significantly dependent on the global cycle, but that present opportunities for earnings upgrades. Two of these themes drove purchases in the second quarter: inexpensively valued, dominant agribusiness, represented through Bayer and its acquisition of Monsanto; and the monetization of music, embodied by Vivendi. Bayer is in the midst of acquiring U.S.-based Monsanto to create the dominant global leader agro-focused group while retaining a solid pharmaceutical franchise. We believe the transaction sets up a prime opportunity to take advantage of significant growth potential at a relatively low valuation. Finally, we believe that Vivendi is poised to take better advantage of the monetization of its music, as the increase in streaming puts an end to 15 years of erosion; in addition, we see the potential for continued international growth, particularly in Africa.
Concerned About Financial Sector Stress
While we are reasonably confident about most of the portfolio, the weak growth and low interest rates characterizing the current economic environment mean that a larger share of gains for equities will have to come from valuation expansion and idiosyncratic ideas. This may benefit both the portfolio and the market, but let’s not forget that the flip side of this situation is the significant stress in the financial sector, especially in Italy. Our research indicates that it may be controlled, but this is a significant area of concern.

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