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Small Cap Value Fund —
Strong performance by the Fund amid mixed results for equities
1st Quarter, 2017
"We continue to position the portfolio based on the underlying fundamentals of individual companies and the growth prospects of companies relative to what is currently reflected in their stock prices. "
– EARNEST Partners LLC

The equity markets rallied significantly in January and February, fueled by investors’ hope for action by the U.S. government on issues such as health care, infrastructure spending and taxes. In March, however, when it became clear that enacting legislation reforming the Affordable Care Act or the tax code would be challenging despite one-party control over the executive and legislative branches of government, stock gains pulled back. A 10% drop in crude oil prices also contributed to the March decline, although oil prices rose near quarter end to close above $50 per barrel, down from $54 at year end.
The Harbor Small Cap Value Fund posted a return of 5.26% in the first quarter of 2017, significantly outperforming the negative performance of its benchmark, the Russell 2000® Value Index, which returned -0.13%. Both stock selection and sector weightings contributed to relative performance, particularly in the Information Technology sector, which was by far the best performing sector in the portfolio during the quarter as investors rewarded fundamentally sound enterprises. Stock selection in Financials and Industrials was also very strong.
EARNEST Partners’ comments were made in an April, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended March 31, 2017, unless otherwise indicated. All references to the year-to-date are for the period January 1 through March 31, 2017.

Interview Highlights


Economic Backdrop
Investors paid close attention to the U.S. Federal Reserve (Fed) during the quarter in anticipation of a rate hike, and the Fed met the market’s expectations at its meeting in March, voting to increase the short-term benchmark rate by 0.25%, to the range of 0.75% to 1.00%, the third rate increase since the end of 2015. The committee noted that a strengthening labor market, moderate economic expansion, and a stable unemployment rate contributed to its decision. Additionally, it noted that inflation continues to perk up, moving toward the 2% long-term target. The committee stated that it believes that as the economy continues to improve, further increases in the federal funds rate will be warranted. Fourth quarter 2016 Gross Domestic Product growth was revised up to 2.1% from 1.9%, and the unemployment rate maintained the 4.7% level in February that was reported in December, compared to 4.9% in February of 2016. The U.S. 10-year Treasury rate, after rising sharply in the prior quarter, remained steady during the quarter, finishing at 2.4%.
Our Skepticism on Regional Banks Was Rewarded
During the fourth quarter of 2016, specifically after the election, small regional banks began to outperform the broader small cap universe. Regional banks ended that quarter with strong performance on the basis that investors presumed these companies would see tax and regulatory relief due to the new administration’s priorities. The Fund’s Manager came to the conclusion that the general perception in the market was not logical and likely not to materialize. We decided to maintain the portfolio’s relative underweight to banks, despite the fourth quarter euphoria in the marketplace. The Fund’s outperformance of the benchmark in the first quarter of 2017 confirmed that this was the right decision.
Maintaining Our Long-Term View
EARNEST Partners doesn’t maintain a formal outlook on the broader equity market. Rather, our investment decisions are made based on a company’s individual opportunities to grow earnings and take market share. Opportunities like these present themselves in all types of market environments, including today’s. Our view on what ultimately drives relative returns has not changed, and is inherent in our ability to identify and take advantage of mispricings in the market on an individual stock-by-stock basis. We continue to position the portfolio based on the underlying fundamentals of individual companies and the growth prospects of companies relative to what is currently reflected in their stock prices.

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 www.harborfunds.com.

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.