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Small Cap Value Fund —
Strong advance for small cap value stocks
2nd Quarter, 2016
"Our view on what ultimately drives relative returns has not changed, and is inherent in our ability to identify and take advantage of mispricing in the market on an individual stock-by-stock basis. "
– EARNEST Partners LLC

During the Federal Reserve Board meeting in June, Chairwoman Janet Yellen decided to rein in previously projected interest rate increases and slow the monetary tightening process to a near halt. As the probability of a Fed rate increase diminished, investors began searching for higher yields in the equity market. The United Kingdom’s referendum vote on June 23rd to exit the European Union (the so-called “Brexit”) sent global equity markets plunging. The British Pound lost 10% against the U.S. Dollar. Global economic conditions did show signs of improving during the quarter, which led to a turnaround in commodities and helped drive equity prices higher among the Energy and Materials sectors.
The Harbor Small Cap Value Fund posted a solid return of 3.07% in the second quarter of 2016, but lagged the 4.31% return of its benchmark, the Russell 2000® Value Index. The Fund’s relative underperformance stemmed from the fact that it was underweight high-yielding sectors due to the price risks that the Manager believes to be inherent in current valuations.
A key detractor to relative performance during the quarter was Hexcel, a leading global materials provider. Among the largest contributors to relative performance was Global Payments, a leading provider of electronic processing services enabling merchants to accept card, electronic, check and digital-based payments at the point of sale. Also contributing to performance was Bloomin’ Brands, an operator of casual dining chains.
EARNEST Partners’ comments were made in a July, 2016 report. Highlights adapted from the report appear below. All comments relate to the quarter ended June 30, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through June 30, 2016.

Interview Highlights

Feeling Effects of Falling Interest Rates
During the quarter, benchmark interest rates continued falling to near record levels as a result of a lack of activity from the Fed as well as the general lack of inflation expectations domestically. As rates fell, due to macro level dynamics, interest-bearing equities continued to draw investor attention. As a result, Utilities, real estate investment trusts (REITs) and Consumer Staples were among the best performing market segments as dividend-seeking investors continued to bid up valuations near record levels. Consumer Discretionary was the only sector in the benchmark to decline during the quarter, as the group generally failed to deliver on high investor expectations. The portfolio was underweight Consumer Discretionary, which proved beneficial.
Sector Allocation Relatively Constant
The portfolio remained overweight the Technology sector during the quarter as compared to the benchmark, because we have found more attractive individual opportunities in Technology relative to other sectors. In addition, we maintained the portfolio’s relative underweight to the Financials sector, as we have found fewer individual opportunities there. Within Financials, the portfolio has a relative overweight to insurance and diversified financial services companies and a relative underweight to REITs and commercial banks as an outgrowth of our process.
Headline Manufacturing Data Down
Among the largest detractors to performance during the quarter was Hexcel, a leading global provider of reinforcement materials and composite structures (such as carbon fiber) for use in aerospace and other industrial applications. During the quarter, increased demand from the commercial aerospace industry drove strong year-over-year sales growth, and operating margins expanded as management focused on improving the efficiency of the company’s manufacturing lines. Despite reporting strong fundamentals for the trailing period, Hexcel shares were down 5% during the quarter as the market focused on softer than expected headline manufacturing data. However, we believe Hexcel should continue delivering solid revenue and earnings growth over our investment horizon, driven by increased production of next-generation commercial airplanes by its largest customers.

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.