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Small Cap Growth Fund —
Small cap growth stocks close Q1 with narrow advance
1st Quarter, 2014
"Meeting with managements over the the last month or two, we have become more constructive on the U.S. economy than we have been in quite some time. "
– Westfield Capital Management Company, L.P.

U.S. equities posted modest gains for the first quarter of 2014, with small cap growth stocks, as measured by the Russell 2000® Growth Index, recording a return of 0.48%. The Energy and Health Care sectors, with gains of about 4%, were the best performing areas of the index. Of the 10 economic sectors in the index, four lost ground during the quarter.
In this environment, Harbor Small Cap Growth Fund outperformed its Russell 2000® Growth benchmark with a return of 2.08% for the first quarter. The Fund also outpaced the index for the period since its inception in 2000.
Health Care stocks, accounting for about 27% of the portfolio, gave the biggest boost to Fund performance in the first quarter, Portfolio Manager Will Muggia reports. The portfolio's Health Care stocks recorded an aggregate return of about 7% for the quarter, compared with the 4% return by those in the benchmark, he notes.
Stock selection and sector positioning both contributed to Fund performance relative to the index. An underweighted position in the Consumer Discretionary sector, the weakest-performing area of the index, aided portfolio returns relative to the benchmark, as did an above-index allocation to Health Care stocks. Strong stock selection among Information Technology and Health Care companies more than offset unfavorable selection in the Energy sector.
Will Muggia’s comments were made in an April 9, 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

Optimistic outlook
Weather was a major issue for a number of industries in the first quarter, but we were consistently impressed by management confidence that once the weather improved growth would be stronger and more reliable than it has been in the last five years. Meeting with managements over the last month or two, we have become more constructive on the U.S. economy than we have been in quite some time.
Taking profits in biotechs
Biotech was a really hot group in January and February and then had a massive correction in March. Despite the big sell-off, biotech stocks were additive to our results. We had some timely exits on several names that hit their price targets. We avoided a lot of the damage and helped preserve capital for the Fund.
Home-related spending
I don't think home prices will go up as much as they did in 2012 and 2013. However, we continue to find attractive investments benefiting from growth in home-related spending. We don't own the home builders right now, but we do own plays in areas such as furniture, lighting, floor covering, and kitchen and bath remodeling. Weather was a negative for housing-related stocks in Q1, but we think some of them may have a very strong Q2.
Rates could rise
One thing that hurt us in Q1 was a lack of exposure to REITs (real estate investment trusts). They benefited from declining interest rates and were the best performing subgroup in the Financials sector. We think the drop in rates in Q1 will be short lived. We're pretty constructive on the economy and we think rates are going to climb higher throughout the year. We plan to remain very much underweight or zero on REITs.
Risk/reward opportunities
In 2012 and 2013 growth was hard to come by so the really attractive fast growers got very high multiples and deservedly so. But with the U.S. economy accelerating, I think some of the best risk/reward trade-offs right now could be in lower P/E names that can meet or beat earnings estimates. Some of the traditional GARP (growth at a reasonable price) stocks I think are very well positioned. Some of those are already in the portfolio and others we're working on right now.

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.