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Small Cap Value Fund —
Small cap value stocks open 2014 with modest advance
1st Quarter, 2014
"Nothing is chronic for us except our pursuit of good results. "
– EARNEST Partners LLC

Small cap stocks opened the new year with modest gains for the three months ended March 31, 2014. The Russell 2000® Value Index, a measure of value-oriented U.S. small cap stocks, returned 1.78% for the quarter, with stocks in the Energy and Utilities sectors posting the biggest gains. Of the 10 economic sectors in the index, the Consumer Discretionary area was the only one to lose ground.
The Harbor Small Cap Value Fund closely tracked the Russell 2000® Value benchmark with a return of 1.68% for the first quarter. From a longer-term perspective, the Fund outpaced the index for the 5-year and 10-year periods ended March 31 and since its inception in 2001.
Portfolio holdings in the Health Care and Materials sectors returned over 10% in the first quarter and were the best performing areas relative to the index, Portfolio Manager Paul Viera reports. Energy and Utilities stocks lagged behind those in the benchmark. Leading individual contributors included GATX in the Industrials sector, Materials holding AMCOL International, and Health Care stocks MEDNAX and Covance.
Paul Viera’s comments were made in an April 9, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2014.

Interview Highlights


Bottom-up selection
We are currently underweighted in Consumer Discretionary stocks, but we continue to look for individual companies in that space with new products or new sectors that we think they will be able to exploit or where we see valuation mismatches between what we think a company is capable of doing and where it's priced today. Nothing is chronic for us except our pursuit of good results.
Fed tapering
The Federal Reserve continued its tapering during the quarter, which is a sign of its confidence in the economy recovering. The other good news about the Fed is that despite a lot of rhetoric about tapering, the market basically yawned, unlike its reaction last year. In fact, interest rates declined during the quarter in the face of tapering and a considerable amount of commentary about increasing tapering.
Q1 performance
The small cap area can be characterized as having done reasonably well in the first quarter, with the index and the Fund both being up about 2%. That was a pretty good result, in our view, given the extraordinary performance in 2013, when both the market and the Fund returned over 30%.
Consumer spending
Our view is not that the consumer has dried up or is going to dry up; the consumer is continuing to spend money. The issue is the prices you have to pay for the growth rates. There has been some fairly significant price appreciation in the Consumer Discretionary space, and valuations have reached pretty full levels, in our view, given what the growth prospects are.
Insurance company indicators
It may seem counterintuitive, but we tend to prefer insurance companies where revenue is growing at a steady rate – not dramatically upward. When you see insurers with a dramatic upward slope, our experience suggests the possibility that, one, they're getting business lines they don't understand and, two, that they're not pricing their business well.

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.