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Small Cap Growth Fund —
Boosted by Health Care stocks, Fund outpaces small cap growth benchmark in Q1
1st Quarter, 2015
"Biotech is an area where we think we've done well over the years, finding companies that have really good science and know how to commercialize it. "
– Westfield Capital Management Company, L.P.

With growth stocks leading the way, shares of smaller U.S. companies advanced in the first quarter of 2015. The Russell 2000® Index, a benchmark for small-company stocks, posted a return of 4.32%.
Small cap growth stocks, as measured by the Russell 2000® Growth Index, returned 6.63% for the quarter, while its value counterpart, the Russell 2000® Value Index, returned 1.98%. The Health Care sector, which made up about a fourth of the small cap growth index, had the biggest positive impact on performance. In all, stocks in eight of 10 economic sectors posted positive returns.
The Harbor Small Cap Growth Fund returned 8.32% for the first quarter, outperforming its Russell 2000® Growth benchmark. Portfolio Manager Will Muggia reports that stock selection drove the outperformance, especially in the Health Care sector, where the Fund returned 19% compared with the 13% return of Health Care stocks in the benchmark. Overall, the portfolio outpaced the index in seven of the nine sectors in which the Fund was invested.
Top contributors to absolute performance for the Fund included Health Care stocks ICON, Prothena, AMAG Pharmaceuticals, and Dynavax Technologies, as well as Watsco in the Industrials sector, a distributor of air conditioning, heating, and refrigeration equipment. Holdings that detracted from returns included Pacira Pharmaceuticals, rent-to-own operator Rent-A-Center, transportation company Saia, business services provider WageWorks, and steel products maker TimkenSteel.
Will Muggia’s comments were made in an April 14, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2015, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2015.

Interview Highlights


Portfolio moves
During the quarter we had 15 new buys across five sectors, which resulted in increased exposure to Information Technology and Health Care. Those are our two largest sector weights, consistent with what you've seen quite a bit over the years. We also had 12 sales across six sectors, which resulted in the Fund having a reduced Energy position as well as slightly smaller positions in Financials and Consumer Discretionary. These were all the result of bottom-up stock decisions, not top-down sector decisions.
Opportunities in biotech
Biotech was a workhorse, with 10 investments contributing to our outperformance in Health Care. We had good stock selection across that space. Biotech is an area where we think we've done well over the years, finding companies that have really good science and know how to commercialize it. We hit a bunch of takeovers in 2014 and I think we could see more of our companies be acquired this year. There has been a lot of M&A in the Health Care sector so far in 2015.
Wary of Energy names
I think oil is going to rebound but we're being very selective in the portfolio. A lot of these energy names are already embedding oil at $75 to $80 per barrel in their share prices, so we're not finding any real bargains. There's a lot of money chasing energy. Just because crude went from $100 to $50 doesn't mean the stocks have dropped that far. We think that crude is likely to bounce but we're not as excited about the stocks.
Restaurant traffic
One of the themes we have had is restaurants. We own several restaurant companies for the first time in a long while. Lower gasoline prices and stronger employment typically are closely correlated with improved restaurant traffic. In addition, we expect to see some lower food costs. It has been a thematic play where we have several holdings that have been really good stocks.
Downside protection
One thing that I think helps to keep a floor on stock prices is the merger and acquisitions environment. A lot of the companies we're meeting with are committed to returning capital to investors; they have excess cash and they're either starting dividends, raising dividends, or buying back stock. At the same time, the top priority for many of these growth companies is acquisitions. If you own the right companies I think you're protected a little bit right now on the downside because there are a lot of people in the wings looking for acquisition opportunities. This could change but I don't see it changing in the near-term.

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.