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International Growth Fund —
Global Politics shocked the International Equities Markets
4th Quarter, 2016
"Much like most of the year, the fourth quarter was dominated by a series of political surprises around the globe. "
– Baillie Gifford Overseas Limited

The final quarter of 2016 was in some ways a microcosm of the year itself. Having started the period weakly, international equity markets navigated a series of exogenous shocks before rallying to finish not far from where they began. The quarter was dominated by a series of political surprises, including the resignation of Italy’s fifth prime minister in ten years, Matteo Renzi; the suspension of South Korea’s President Park Geun-hye; and the surprise election of Donald Trump as the 45th U.S. president. While the long-term impacts are yet to be seen, several economic indicators across the developed and developing world are looking better than they have for some time.
For the fourth quarter of 2016, the Harbor International Growth Fund posted a return of -7.85%, underperforming its benchmark, the MSCI All Country World Ex. US (ND) Index, which returned -1.25%. The Fund’s relative underperformance was due mostly to stock selection and an underweight in Financials, with stock selection in Consumer Discretionary also having a negative effect. Having no exposure to Telecommunication Services and Utilities, which had negative returns in the benchmark for the quarter, aided relative results.
Baillie Gifford’s comments were made in a January, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended December 31, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through December 31, 2016.

Interview Highlights

2016: The Year in Review
The year 2016 can be summed up as “mixed.” It started slowly in January, as the world fretted about deflation, stalling growth and a collapsing oil price, then built up into a rather eventful year with a series of notable political surprises. Having traded broadly sideways for the first half of the year, global markets threw a tantrum around the United Kingdom’s unexpected vote to leave the European Union (E.U.) in June’s referendum. The U.K. market and other global equity indexes dropped in the immediate aftermath, but have since recovered and even moved to new multi-year highs. In the final quarter came the resounding defeat of Matteo Renzi’s constitutional reform proposals in Italy, which resulted in his resignation. The election of Donald Trump also came as a surprise, and his policies will no doubt have implications beyond America itself. Markets were stronger than some had predicted, and returns overall turned out to be positive for the year. Equity markets in Italy and the U.S. saw their sharpest rises in the last few months of the year.
Political Uncertainty for the Foreseeable Future
As we begin 2017, we believe we will see a continuation of political uncertainty. Macroeconomic and geopolitical issues such as the war in Syria and mass migration of refugees into Europe, the hollowing out of traditional industries in the West due to globalization, and rising wealth inequality and stagnation of real incomes for lower-income workers across much of the developed world are not going to be resolved in the near-term. There seems little point in assuming that the dissatisfaction these issues have caused will disappear. In Europe, 2017 will see general elections in Germany, France and the Netherlands. In each of these elections, there exist populist and/or extremist political parties with the potential to disturb the status quo.
Reasons for Optimism Despite Uncertainty
We realize that there is a risk of being too downbeat, however. While political predictions have proven to be futile, so too have been the assumed effects of the shocks themselves. What the long-term impact of the new political regime in the United States will be is still unclear but, while experts were largely united in emphasizing the downside risks of Donald Trump’s policies prior to the election, it is notable that the immediate response of the equity markets has been for the S&P 500 to rise to new highs. The U.K. economy has continued to confound those who were convinced that a vote to leave the E.U. would result in an immediate and dramatic decline in its health. In Italy, the transition to a new prime minister appears to have been handled smoothly, major banking-sector recapitalization has been approved by the parliament and Italian equities have delivered their strongest month since April 2009. Far from melting down, several economic indicators across the developed and developing world are improving, deflation fears are receding across Europe, and monetary policy normalization continues in North America.

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