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Small Cap Growth Fund —
Q4 rebound lifts small cap shares into positive territory for 2014
4th Quarter, 2014
"Lower energy prices, combined with healthy job growth and modest improvement in wages, should provide a definite tailwind to consumer spending in 2015, in our view. "
– Westfield Capital Management Company, L.P.

Shares of smaller U.S. companies rebounded in the fourth quarter to finish 2014 in positive territory. The Russell 2000® Index, a benchmark for small-company stocks, registered returns of 9.73% for the quarter and 4.89% for the 12 months ended December 31, 2014.
Small cap growth stocks, as measured by the Russell 2000® Growth Index, returned 10.06% for the fourth quarter and 5.60% for the full year. Eight of the 10 economic sectors in the index posted positive returns for the quarter. Health Care and Information Technology, representing almost half of the index, were among the stronger performing sectors, while Energy and Utilities, accounting for about 4% of the index, had double-digit declines.
The Harbor Small Cap Growth Fund posted returns of 8.64% for the fourth quarter and 8.28% for the year, outperforming the Russell 2000® Growth benchmark for the full year while trailing it for the latest three months. The Fund also outpaced the index for the 10-year period ended December 31, 2014, and since its inception in 2000.
Portfolio Manager Will Muggia reports that stock selection in the Energy and Industrials sectors helped Fund performance in the fourth quarter relative to the benchmark, while portfolio returns from the Information Technology and Health Care sectors trailed those of the index. A larger-than-index exposure to the weak-performing Energy sector also hurt relative performance. Sector allocations typically are a result of individual stock selection choices rather than an active aspect of investment strategy for the portfolio.
Among the top contributors to absolute performance for the Fund were Health Care stocks Cubist Pharmaceuticals and AMAG Pharmaceuticals, Industrials names Watsco and JetBlue Airways, and Tesoro in the Energy sector. All had share price gains of more than 20%. Among the bigger detractors from performance were Superior Energy Services and Oil States International in the Energy sector, Health Care holdings Aegerion Pharmaceuticals and ICON, and Power Solutions International in the Information Technology sector.
Will Muggia’s comments were made in a January 13, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2014.

Interview Highlights


Sector exposures
In terms of sector weights the only notable changes in the fourth quarter were a big increase in Consumer Discretionary and a big decrease in Energy. We had some timely increases in Consumer Discretionary, which went from 12.5% of the portfolio to over 15.5%. Consumer went up about 300 basis points, or 3 percentage points, and Energy went down about 300. Energy ended the year at 4.6%, which we think should set us up well going into 2015.
Cyber security
Internet security has become a hot topic. Web-based applications, cloud computing, and enterprise software have all opened the door for new cyber attacks. The recent attacks on Target and Home Depot have highlighted the need for improved IT security. Security has become a CEO and board-level issue. It is a big area of focus for us and could be an important growth area going forward.
Auto applications
Technology is quickly penetrating many parts of the automobile – transmission, drive train, entertainment, safety, and electric hybrids. We feel that technology content is going to grow higher than global auto production for the next three to five years. We’re investing in Information Technology companies that sell into the automotive industry.
Consumer outlook
Lower energy prices, combined with healthy job growth and modest improvement in wages, should provide a definite tailwind to consumer spending in 2015, in our view. We added 300 basis points to our Consumer Discretionary exposure during the fourth quarter. One area where we now have significant exposure is restaurants, which we see as an early beneficiary of lower gasoline prices. Improved restaurant traffic, coupled with lower food costs, should have some good earnings upside, in our view.
Low global rates
What's happening with global interest rates right now is fascinating. Sovereign debt yields are plummeting to historic lows, and low global rates are pressuring U.S. rates. With global growth really slow, I think it’s going to be hard for the Federal Reserve to raise rates by a lot. I think they're going to raise a little, because the U.S. economy is in pretty good shape. But I don’t think we will see rapidly escalating interest rates by any means.

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.