Investors face a mixed macroeconomic picture in the year ahead, in the views of Portfolio Manager Ted Wendell and Senior Analyst Scott Babka of the Harbor International Fund. Although Europe continues to struggle with sovereign debt issues, they believe that China and the emerging markets will remain the leading source of global growth and that sluggish economic recovery will continue in the U.S.

After a sharp drop in the third quarter, international stocks managed a modest gain in the fourth, with the MSCI EAFE (ND) Index posting a return of 3.33%. For the full year, however, the index was down -12.14%. The Harbor International Fund outperformed the MSCI EAFE benchmark for both periods, registering returns of 7.35% for the fourth quarter and -11.13% for the year. From a longer-term perspective, the Fund continued to outpace the benchmark by substantial margins for the 5-year and 10-year periods ended December 31, 2011.

Wendell and Babka report that stock market weakness enabled the Fund to add quality names to the portfolio in 2011. They note that the investment team's focus is on companies with leading positions in growing global markets.

The comments by Ted Wendell and Scott Babka were made in a January 11, 2012, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2011, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2011.

In the fourth quarter we bought Toyota, sold Banco Santander, and reduced our exposure to A.P. Moller - Maersk. You're seeing a company coming into the portfolio that reflects our view on the continuing recovery in the U.S. On the sell side you see the exiting of a European-based financial and also the selling down of a company that benefits from shipping goods to Europe, which continues to face economic headwinds.

The volatility in the market has helped us add some strong global franchises. In addition to Toyota, I would include SAP, Rolls-Royce, and Taiwan Semiconductor. We think these are good examples of sticking to our philosophy of buying market leaders that have pricing power and are operating in consolidating markets.

On a recent visit to China, we toured a number of factories that are doing well but facing inflation pressures. These can be offset at least in part through improved automation and operating efficiencies, which we think plays to the strength of a number of companies in the portfolio, such as ABB, Fanuc, Atlas Copco, Sandvik, and Schneider. These are companies with great management, strong pricing power, high barriers to entry, and already-dominant market shares in China and emerging markets. Most of them are domiciled in Europe but even under a worst-case scenario these are 3% or 4% dividend-yielding companies that we feel confident in holding.

We're still strong on the Materials group. The third largest company we own is Atlas Copco, not directly a mining company but one that sells to the mining industry. Part of our theme is that growth is still happening in China and that the demand for raw materials such as iron ore and copper is still strong.

Toyota is a stock we've owned in the past. It has fallen out of favor since we sold it because of weakness in the U.S. auto market, problems with recalls, and dislocations resulting from the earthquake in Japan. Upon evaluation, however, we don't think the franchise is broken. This is still a leader in terms of technology and global scale. We expect to see a big improvement in operating margins over the next few years, which is not reflected in the share price today.