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Small Cap Growth Fund —
A quarter of underperformance for small caps and growth stocks
1st Quarter, 2016
"We continue to believe that high quality businesses at reasonable valuations over time will outperform. "
– Westfield Capital Management Company, L.P.

During the first quarter of 2016, U.S. equity markets declined early before rebounding in the second half of the quarter. Overall, small cap stocks underperformed large and mid cap stocks, and growth stocks underperformed value stocks. In the U.S. small cap growth equity market, the Health Care and Energy sectors led the decline during the quarter. The Telecommunication Services and Industrials sectors had positive results.
For the first quarter, the Russell 2000® Growth Index, a measure of growth-oriented companies in the small cap segment of the U.S. market, returned -4.68%. The Harbor Small Cap Growth Fund underperformed the index with a return of -7.22%. The negative impact from stock selection in the Consumer Discretionary sector more than offset the positive effects of an overweight position and detracted significantly from the Fund’s relative performance for the quarter. Stock selection in the Industrials sector also hindered relative results. The Fund benefited from stock selection in the Information Technology and Energy sectors.
One of the Fund’s largest detractors from relative performance was Restoration Hardware. The company lowered its earnings and revenue guidance, and the Manager trimmed the Fund’s position during the period. An individual contributor to the Fund’s relative results for the quarter was Proofpoint, a data security provider. The company sells a broad platform of products and experienced market share gains. In addition, it recently signed a cross-selling agreement with Palo Alto Networks.
Portfolio Manager Will Muggia’s comments were made in an April 12, 2016 interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through March 31, 2016.

Interview Highlights

No Major Portfolio Changes
In the second half of the first quarter, U.S. equity markets recovered from earlier declines. The recovery was led by the Industrials, Energy, and Consumer Discretionary sectors. The best performing companies in the second half of the quarter included many companies close to bankruptcy, companies that have attracted negative sentiment and companies with a lot of debt. We don’t believe this type of market move is sustainable, and we started to see some moderation and reversal in March. We did not make any sweeping portfolio shifts or changes, and we continue to believe that high quality businesses at reasonable valuations over time will outperform.
Positioning in Information Technology
Information Technology vendors continue to feel pressure as people move to cloud computing. We believe enterprise spending is stable in the areas where we’re invested. We see continued strength in security, analytics and cloud computing, while we see weakness in hardware and consumer technology spending as PC and handset demand has been weak. A new name in the portfolio is Proofpoint.
Positioning in Health Care
Following a big rebound in the fourth quarter of 2015 in the Health Care sector, we reduced our exposure to the sector. We have been trying to balance our constructive views on research and development productivity and new product cycles, which we believe are quite good, with the realization that headwinds for the sector will likely include political chatter and negative headlines heading into a presidential election. We have some holdings in what we view as the most attractive therapeutic category in biotechnology, which is oncology. Such companies are generally protected from pricing pressure and insulated from competition. We think this area is the most likely for merger and acquisition activity to begin, particularly because of the correction in valuations in that space. We also have investments in medical technology. We believe these companies have strong top- and bottom-line growth potential, as well as solid margin expansion opportunities.
Our Outlook on the U.S. Equity Market
I would say the biggest change for our outlook on the U.S. equity market is that global purchasing managers’ indexes look to be hitting a trough. And I’m less negative about China because people are now more realistic about how much China can grow. We believe the global market seems to be healing, while in the U.S., the manufacturing and non-manufacturing indexes are positive, and the Dollar’s recent decline has paused. Overall, the macro picture looks a little better to us.

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

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.