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International Fund —
International shares record modest advance in Q1
1st Quarter, 2014
"Many of our companies are multinationals that have significant exposure to emerging markets. "
– Northern Cross, LLC

Equities in developed overseas markets closed out the first quarter of 2014 with a narrow gain, as the MSCI EAFE (ND) Index posted a return of 0.66%. Stocks in the Health Care and Utilities sectors were the best performers in the index. Shares of companies based in Switzerland, Australia, France, and Italy were the biggest contributors to absolute performance for the index, while Japan was the largest detractor.
The Harbor International Fund slightly outperformed the MSCI EAFE (ND) benchmark with a return of 1.03% for the three months ended March 31, 2014. The outperformance was driven primarily by stock selection in the Financials and Health Care sectors.
Health Care holdings Novo Nordisk, Roche, and Novartis were among the major contributors to absolute returns for the Fund in the first quarter, along with Italian bank Intesa Sanpaolo and Swedish automotive manufacturer Volvo. Detractors included aircraft engine manufacturer Rolls-Royce, Energy sector holding BG Group, and U.K.-based publisher Pearson.
From a country-level perspective, a smaller-than-benchmark exposure to Japan, along with favorable stock selection in Japanese companies, proved to be a major contributor to relative performance. Japan weighed heavily on returns of the MSCI EAFE (ND) Index, as its Japanese companies posted an aggregate decline of -5%. Japanese shares represented about 20% of the index compared with about 9% of the Fund.
The investment team is finding opportunities in a variety of areas, including robotics, pharmaceutical research, and electrical grid systems, Portfolio Manager Jim LaTorre reports. The Fund maintains a significant exposure to emerging markets, both directly through companies based in developing countries, as well as indirectly through multinational companies serving emerging markets, he notes.
The comments by Jim LaTorre were made in an April 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2014.

Interview Highlights


Improving margins
We're six years into the recession and excess capacity in some industries is starting to go away. As excess capacity is reduced, you begin to reach a point where you can envision stronger pricing power. If this were to happen, you could see an improvement in margins above and beyond what we've already experienced.
Global competition
Germany is not seeing a head-to-head competition with the weak Japanese Yen yet because German exports are often bought for their specific merits. It’s not all about price. It is our view that the impact of a drop in the value of the Yen on most industries is small. You're seeing that now in Japan: export numbers are not picking up that much.
Economic outlook
I'm not an economist but I think the U.S. economy is strong. We hear a lot about deflation in Europe but we don’t see that happening. We think the European Central Bank will do everything to prevent that. We don’t see China falling apart, although we do see a lot of excess capacity in China.
Emerging market growth
Many of our companies are multinationals that have significant exposure to emerging markets. We often prefer investing indirectly in emerging market growth, particularly with some of the consumer brands. Many of these developing economies thrived by manufacturing things more cheaply than we could in the U.S., but the next wave of growth for these economies should be primarily domestic, including branded consumer products where we have exposure.
Long-term perspective
We haven't found anything in solar energy to invest in as of yet. But if you take a 10-year view on the cost curve in solar, we believe it will be competitive. We have added to our positions in ABB and Schneider Electric, two companies that we think could benefit from power storage in the grid that could come from solar.

Performance figures discussed reflect that of the institutional class shares.

The views expressed herein are those of the portfolio manager at the time of the interview and may not be reflective of their current opinions or future actions.  These views are not necessarily those of the fund company and should not be construed as such.

This information should not be considered as a recommendation to purchase or sell a particular security and the holdings or sectors mentioned may change at any time and may not represent current or future investments.