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Small Cap Value Fund —
Small Cap Value Fund records 12-month return of over 35%
4th Quarter, 2013
"...we try to discriminate in favor of higher-quality names, which we think should put our portfolio in an advantageous position over time. "
– Paul Viera

U.S. equities closed out a strong 2013 performance with a solid advance in the fourth quarter. The Russell 2000® Value Index, a measure of value-oriented U.S. small cap stocks, posted returns of 9.30% for the three months ended December 31, 2013, and 34.52% for the calendar year.
In this environment, the Harbor Small Cap Value Fund outperformed the index for the full year with a return of 35.60%, although its 8.04% return for the fourth quarter lagged that of the Russell 2000® Value benchmark. Longer term, the Fund outpaced the Russell 2000® Value benchmark for the 5-year and 10-year periods ended December 31 and since its inception in 2001.
Stock selection across a variety of sectors was a key factor in the Fund's outperformance of the benchmark for the calendar year, Portfolio Manager Paul Viera reports. Top individual performers in the portfolio included Core Laboratories, Lufkin Industries, Hexcel, EnerSys, and Protective Life.
In the fourth quarter, portfolio holdings in the Health Care, Consumer Discretionary, and Utilities sector hurt performance relative to the benchmark, Viera notes. Sector allocations are typically a result of the investment team's bottom-up stock selection process. Leading individual performers included TAL International, American Equity, Raymond James, and Global Payments, all with share-price gains of better than 20% in the quarter.
Despite the strong stock market advance in 2013, equity valuations remain at reasonable levels on a historical basis, in Viera's view. He also believes that investment opportunities in the small cap value sector remain attractive relative to those in other asset classes.
Paul Viera's comments were made in January 15, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2013, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2013.

Interview Highlights

Broad-based returns
The key for us was individual stock selection. In 2013 the Fund outperformed the benchmark across a variety of economic sectors. It wasn't as if we had a huge weight in one sector and it did remarkably well; rather, we had a diversified return across the spectrum. We think that reflects a more stable portfolio, and that has been one of our aims over the years.
Focus on quality
Over the past year we think there has been a certain amount of indiscriminate buying in the small cap value space, driven in part by an infusion of capital from the Fed's monetary stimulus programs. By contrast, we try to discriminate in favor of higher-quality names, which we think should put our portfolio in an advantageous position over time.
Alternative investments
If you look at valuations among small cap value equities relative to whatever else you could own, whether it be other equity markets, real estate, bonds, or other asset classes, I think the premiums are consistent and maybe even slightly cheap relative to what they have been historically. Relative to other things you could own, I think the small cap value space is still a pretty good place to be.
Balanced portfolio
About a fifth of the portfolio is invested in Financials, while the index has almost 40%. The result, in our view, is that we have a better balanced portfolio with respect to risk. Although we are generally finding better alternatives elsewhere, we continue to look for opportunities among Financials, and I think we did a good job in 2013.
Low-inflation backdrop
Valuations are within the range of what we have seen historically, so in our view the market is not rich on that basis. If we had these valuation levels in a high-inflation environment, you might wonder how much real return you could reasonably expect. But in the low-inflation environment we have today, the opposite is true and I think there is good value there.

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.