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International Fund —
Foreign shares moved higher in Q2, led by Energy and Utilities
2nd Quarter, 2014
"We are always on the lookout for opportunities in developing markets, and by and large our investments have been in the multinational space in developed markets with emerging markets exposure. "
– Northern Cross, LLC

International stocks advanced in the second quarter of 2014, as the MSCI EAFE (ND) Index recorded a return of 4.09%. The index is a measure of equities in developed overseas markets. Every sector in the index gained ground, with Energy and Utilities stocks posting the highest returns.
The Harbor International Fund returned 3.37%, trailing the index. Underweighted exposures in Energy and Utilities hurt Fund returns relative to the MSCI EAFE (ND) benchmark. Stock selection in the Financials sector helped relative returns. From a longer-term perspective, the Fund outperformed the index for the latest 5-year and 10-year periods and from its inception in 1987. The Fund is managed by Northern Cross, LLC.
Looking ahead, the investment team believes that European economies are continuing to recover but that banks in Europe still face risks stemming from additional non-performing loans as well as tighter regulatory requirements. Consequently, according to Scott Babka, Principal and Director of Research, the team is focusing on higher quality, well-capitalized banks that earn revenues from a variety of sources.
In the Industrials sector, portfolio companies such as Schneider Electric, Atlas Copco, ABB, Fanuc, and SMC could be well positioned to benefit as the global recovery continues, Babka notes. Recent additions to the portfolio include Swatch Group, the Swiss watch maker, Babka reports.
The comments by Scott Babka were made in a July 15, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended June 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through June 30, 2014.

Interview Highlights

Improving productivity
Global multinationals have a lot of opportunities to use a combination of low-cost labor and increased automation in Eastern Europe as well as Mexico, to improve productivity and operating margins. In our view this has positive implications for some of the German auto manufacturers like Daimler as well as tire maker Pirelli. I think it also has positive implications for some of the industrial cyclicals in the portfolio. This includes Schneider Electric, Atlas Copco, and ABB in Europe, as well as Fanuc and SMC in Japan. As demand recovers, we think you’re going to see these companies called upon to add to productivity and you're going to see an expansion of capacity in these low-cost regions of the world.
Well capitalized banks
We are confident that the European economies are gradually improving but the depth and length of this downturn means that the level of non-performing loans across the banking system is still very high. That means there are risks that banks will need to take additional charges on non-performing loans and some European banks could be deemed to be short of capital in the eyes of regulators. What we have done is focus on owning some of the most highly capitalized banks in the most consolidated markets. Those include BBVA in Spain, Lloyds in the U.K., and Intesa Sanpaolo in Italy. These are banks that we believe have sufficient capital to absorb further charge-offs if necessary.
Attracting multinationals
[Portfolio Manager] Jim LaTorre and I recently traveled through Turkey, Poland, Hungary, and Romania touring factories and meeting with government officials, banks, and local companies. This is part of our ongoing research to understand how different parts of the world are developing and how that might impact the companies in our portfolio as well as those on our watch list. It is very clear from that trip that these countries are aggressively looking to attract investment from global multinationals. Wage levels are much lower than in Western Europe and we believe there is going to be a continued shift in manufacturing and IT outsourcing to these countries.
Developing markets
We are always on the lookout for opportunities in developing markets, and by and large our investments have been in the multinational space in developed markets with emerging markets exposure. For example, BBVA is a play on Mexico. We also have looked at some of the pure-play companies based in emerging markets but we want to be mindful of risk, which is why you haven’t seen us make those investments.
Cost advantage
Swatch is vertically integrated, which we think gives it a strong position in the luxury goods market. It produces the complex movements that go into a watch, and that manufacturing base is quite large. It supplies about half of the Swiss watch industry - its own brands, such as Tissot and Longines, as well those of other companies. We think that provides a barrier to entry that can’t be replicated and it should give them a cost advantage over competitors.

Performance data shown represents past performance, which is no guarantee of future results. Current performance may be higher or lower than the past performance data shown. Investment returns and the value of an investment will fluctuate, and an investor's shares, when sold, may be worth more or less than their original cost. You can obtain performance data current to the most recent month-end (available within seven business days after the most recent month-end) by calling 800-422-1050 or visiting

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