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Small Cap Growth Fund —
Harbor Small Cap Growth outpaces benchmark in down quarter
3rd Quarter, 2014
"...we're a little more positive on small caps right now because they don't have the same exposure overseas where you're seeing the weakness. "
– Westfield Capital Management Company, L.P.

Shares of smaller U.S. companies lost ground in the third quarter, pushing their returns into negative territory for the first nine months of 2014. Small cap growth stocks posted a return of -6.13% for the quarter, as measured by the Russell 2000® Growth Index. On a year-to-date basis, the index returned -4.05%.
The Harbor Small Cap Growth Fund also posted negative returns but outperformed the Russell 2000® Growth benchmark. The Fund recorded returns of -2.23% for the third quarter and -0.33% for the first nine months. The Fund also outpaced the index for the 12-month, 5-year, and 10-year periods ended September 30, 2014 and since its inception in 2000.
Portfolio Manager Will Muggia reports that stock selection was the key factor in the Fund's outperformance in the third quarter, especially in Health Care, the largest sector weight in the portfolio. The Fund's Health Care stocks returned 10% compared with a decline of -3% in the benchmark index. Investment decisions in the Energy and Information Technology sectors also boosted relative performance, while portfolio holdings in the Consumer Discretionary sector lagged those in the index, Muggia notes.
The portfolio's top individual performers included Health Care names PTC Therapeutics, ICON, AMAG Pharmaceuticals, and Anacor Pharmaceuticals, as well as XPO Logistics in the Industrials sector, all with share price gains of more than 20%. The biggest detractors from Fund performance included Industrials holdings Watsco and Huron Consulting Group, Consumer Discretionary names Restoration Hardware and Lithia Motors, and KapStone Paper and Packaging in the Materials sector.
Will Muggia's comments were made in an October 9, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended September 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through September 30, 2014.

Interview Highlights


Source of strength
Our Energy stocks were flat while the benchmark was down 17%. Stock selection drove all the upside and the portfolio's refining positions were the biggest source of strength. We avoided the debacle that occurred mostly in exploration and production companies, an area where we rarely invest. We just don't understand the valuations there.
Cloud software
The transition to cloud-based business models continues, as cloud software vendors have continued to take share from the large incumbent vendors. Recent earnings results have highlighted the divergence between companies that rely on capital-intensive expenditures, in the form of hiring people and physical servers, versus cloud-centric solutions that help optimize businesses and allow for lower spending on physical capital.
Internet transition
Among Internet businesses, there has been a swift transition to mobile from desktop. It was previously a headwind to monetization; now it's a tailwind. Those companies that can prove they can monetize mobile are definitely poised to do well, in our view. We're focused on Internet companies with not only dominant market positions but also strong monetization opportunities in mobile.
Online retail
Consumer Discretionary has continued to be a tough space. Overall share of consumer spending continues to move online and is pressuring traditional retail, which was arguably already overbuilt in terms of bricks and mortar locations. Retailers with undifferentiated products or brands are struggling. We are looking for things that are unique and moving online.
Weak global growth
Small caps have been the worst performing group so far this year and large caps have been the best. We think that might not make a lot of sense at this point given fears of slowing global growth. If you look at S&P 500 earnings, 30% or 40% are overseas, Europe being a big portion of that. So we're a little more positive on small caps right now because they don't have the same exposure overseas where you're seeing the weakness.

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 www.harborfunds.com.

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.