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Small Cap Value Fund —
Stocks in yield-oriented Utilities and REIT sectors were market leaders
3rd Quarter, 2015
"If one is willing to take a long-term view and be patient, volatility is our friend, because it allows us to take advantage of mispricings. "
– EARNEST Partners LLC

Value-oriented shares of smaller U.S. companies declined in the third quarter of 2015, with the Russell 2000® Value Index posting a return of -10.73%. Cyclical sectors such as Energy, Materials, and Industrials were the worst performers within the index, while the perceived safer, income-producing Utilities and REITs outperformed on a relative basis.
The Harbor Small Cap Value Fund posted a return of -11.21%, underperforming the index by -0.48%. For the year-to-date period, the Fund was down -8.65%, outperforming the index’s return of -10.06%. A large underweight to Financials and poor stock picking in that sector was the major driver of relative underperformance during the quarter. Good stock selection within Information Technology, Materials, and Health Care helped to offset this headwind.
Within Financials, not holding any commercial banks and a sizable 12% underweight to REITs were the largest determinants of sector underperformance. Additionally, overweights to a number of consumer finance firms, including TAL International, CAI International, and Enova International also detracted from results as these names sold off significantly during the quarter. Within Information Technology, positive stock selection in IT services, including holding Global Payments, was additive to performance and helped to offset negative returns. Within Materials, an overweight to chemicals firm Scotts Miracle-Gro also helped results.
Portfolio Manager Paul Viera reports that Financials continued to be the most significantly underweight area of the Fund, representing about 22% of the portfolio compared with about 43% of the small cap value index. As of September 30, the largest overweights relative to the benchmark continue to be Information Technology, Industrials, and Health Care.
Paul Viera’s comments were made in an October 15, 2015 interview. Highlights adapted from the interview appear below. All comments related to the quarter ended September 30, 2015, unless otherwise indicated. All references to the year-to-date are for the period January 1, 2015 through September 30, 2015.

Interview Highlights

China the Main Driver of Market Sell-Off
China was the instigator for the sell-off in both global markets generally and the small cap space specifically for the third quarter. China announced that its GDP figures were going to be curtailed and that its exports were down, and this slowdown had negative implications for global growth prospects, which negatively impacted markets. In a risk-off, flight to safety environment, small cap stocks were disproportionately punished.
Fed and Uncertainty around Rate Increase
When the Fed looked at China data and concerns over slowing global economic growth, it may have caused them to back off on the announcement that it was going to raise rates. Increased uncertainty around the timing of an increase in interest rates by the Fed may have led some market participants to believe that the world economy might be in slightly worse shape than previously forecasted. The uncertainty of Fed liftoff and increased concerns about the state of the world economy likely contributed to the sell-off in risk assets, including small cap equities, during the quarter.
REITs are Overvalued
Financial stocks did relatively better than all other stocks during the quarter, which, in our view, was mostly driven by REITs, which comprise a meaningful portion of the Financials stocks in the small cap value space. REITs are relatively high yielding securities as they are required by law to pay out a majority of their earnings via dividends. In a period that saw yields on Treasury bonds fall, many investors sought income alternatives, including REITs, and this part of the market performed particularly well. However, if you analyze REITs from a valuation point of view, they are materially overvalued versus their history. Therefore, we still feel comfortable being underweight the industry.
Opportunities for Active Management Going Forward
We believe if you are able to perform fundamental analysis on a business and able to have a differentiated view on a company versus the market, then you provide yourself an opportunity to outperform over the long-term. With a lot of money flowing into ETFs and passive strategies, it may increase market volatility, which may create opportunities for an active manager to exploit market inefficiencies. If one is willing to take a long-term view and be patient, volatility is our friend, because we believe it allows us to take advantage of mispricings.

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.