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Capital Appreciation Fund —
Q4 rally lifts large caps into positive territory for 2011
4th Quarter, 2011
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"What gives me some confidence is the valuation of the equity market, particularly versus other investment vehicles. "
– Sig Segalas

Large cap U.S. equities finished a turbulent 2011 in positive territory, thanks to a year-end rally. The Standard & Poor's 500 Index registered returns of 11.82% for the fourth quarter and 2.11% for the full year, while the Russell 1000® Growth Index of large cap growth stocks gained 10.61% for the quarter and 2.64% for the year. U.S. mid cap and small cap stocks also rallied in the fourth quarter but both groups ended up losing ground for the full year.
With a portfolio focused primarily on large cap growth stocks, the Harbor Capital Appreciation Fund returned 7.11% for the fourth quarter and 0.61% for the 12 months ended December 31, 2011. Portfolio Manager Sig Segalas reports that Amazon, Salesforce.com, Oracle, and Illumina were among the most significant detractors from performance in the quarter, while leading contributors included Google, Starbucks, MasterCard, Estée Lauder, and Monsanto.
Segalas expresses cautious optimism about the outlook for 2012. He cites attractive equity valuations and a gradually improving economic picture in the U.S.
Sig Segalas's comments were made in a January 18, 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.

Interview Highlights

Cautious optimism
Last year was very volatile and I'm glad we're in 2012. We are cautiously positive as we enter this year. In the fourth quarter, economists started feeling a little better about the U.S. economy, even though Europe was still having serious problems and most pundits right now would say Europe is in recession.
Upside surprise
What gives me some confidence is the valuation of the equity market, particularly versus other investment vehicles. The S&P 500 is selling close to 12x earnings, which I think is near a historic low. Profits this year will not grow as fast as they have in the recent past. My guess is they'll be up high single-digits instead of double-digits as we've seen recently. But with the valuation support I think the market is quite cheap. I think we could be surprised on the upside.
Taking profits
We cut back on a couple of names during the fourth quarter. We took some nice profits out of IBM. It's still an important holding in the portfolio but the stock had done very well and had a nice multiple expansion. We trimmed our exposure a bit although we still think it's going to do well.
Volatile situation
People are feeling a little more comfortable about Europe but it's still a volatile situation. Europe is in a recession and it's important that some of the policies they're implementing take hold and that gradually, by the end of the year, Europe is able to come out of this difficult period.
Increasing dividends
Balance sheets are very strong and cash flows are at record highs, so I would expect a number of companies to continue to increase dividends in 2012. I think within a year or so we may very well see Apple pay its first dividend. The company is generating a lot of cash and I wouldn't be surprised to see Apple start paying a reasonable dividend.

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.