Harbor Funds | Manager Commentary

News & Commentary

Small Cap Growth Fund —
Q4 rebound trims small cap losses for 2011

4th Quarter, 2011

"We're not saying housing is great but there are a lot of signs that it has bottomed. "
– Will Muggia

Small cap stocks rebounded in the fourth quarter of 2011, with the Russell 2000® Growth Index posting a return of 14.99%. The Harbor Small Cap Growth Fund outperformed the index with a return of 15.72%. Investments in the Information Technology and Materials sectors were among the leading contributors to Fund returns relative to the index, while Energy names were the biggest detractors from relative performance, reports Portfolio Manager Will Muggia.

Despite the surge in the final quarter, small cap growth stocks finished 2011 in negative territory. The Russell 2000® Growth Index registered a negative return of -2.91% for the year, while the Fund was off -7.66%. The Fund nonetheless continued its long-term outperformance of the index for the 5-year and 10-year periods ended December 31, 2011.

Looking ahead, Muggia and his team see continuing progress in the U.S. economic recovery, including a bottoming-out of the downturn in housing. These expectations are reflected in portfolio positions in a number of areas, including the Industrials, Financials, and Consumer Discretionary sectors.

The Fund has trimmed its exposure to companies linked to European markets, Muggia reports. He believes the sovereign debt crisis will eventually be resolved but he is not optimistic on the region's macroeconomic outlook for 2012.

Will Muggia's comments were made in a January 12, 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

U.S. housing market

One of the themes we have going into 2012 is that the U.S. housing market has bottomed. We're not saying housing is great but there are a lot of signs that it has bottomed. If so, that could be very good for banks, particularly regional banks. We added several regional banks that have been very good performers and we think that could be an area of solid contribution in 2012.

Positive view on manufacturing

The area I'm probably most excited about is the Industrials. It's the largest sector weight in the portfolio and by far the largest overweight relative to the benchmark. Part of that is our expectation of a resurgence in U.S. manufacturing. And if the housing and auto industries have both bottomed that would be really good for the Industrials.

Dividend growth

There was a lot of talk last year about dividend yield, and sectors such as Consumer Staples, Utilities, and REITS did very well. But I feel that the pure-yield plays have become too expensive. On the other hand there are dividend-paying stocks with 1% to 2% yields, where they're growing the dividend, buying back stock, and returning capital. These are all things that we're looking at in 2012.

Energy outlook

One of the themes we have in the Energy space is that we expect to see very low natural gas prices for the next 10 to 20 years. That could be a major U.S. competitive advantage. We think it would be hugely positive for U.S. manufacturing.

Economic recovery

I think the U.S. right now is the best-positioned economy in the world. We are still in a de-leveraging, slow-growth environment, grinding it out. But I think U.S. employment is going to start getting better, and with an improvement in autos and housing we could see a kind of renaissance in manufacturing.