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Mid Cap Value Fund —
Mid cap value stocks solid in second quarter
2nd Quarter, 2016
"Value stocks outperformed in the quarter, but our focus on cash flow and earnings was not rewarded as defensive sectors and stocks of lower quality – that are nonetheless relatively expensive – led the market. "
– LSV Asset Management

Despite some steep losses immediately following the Brexit, the U.K.'s vote to leave the European Union, U.S. equities posted steady gains throughout most of the second quarter of 2016 and finished in positive territory.
Against this backdrop, mid cap stocks outperformed large cap stocks, although small cap stocks led U.S. equities. The Russell Midcap® Index advanced 3.2% in the second quarter, compared to a 2.5% return for the S&P 500, while small cap stocks, as measured by the Russell 2000® Index, gained 3.8% for the period. Value stocks, as measured by the Russell indices, led the market across all market cap ranges. Among mid cap stocks, value outperformed growth substantially: 4.8% versus 1.6%.
The Harbor Mid Cap Value Fund returned -1.03% in the second quarter, underperforming its benchmark, the Russell Midcap® Value Index, which was up 4.77%. Stock selection detracted from relative returns in all sectors held, particularly in Energy, where lower quality stocks rebounded to help the sector lead the benchmark. Holdings among department stores, retailers and auto parts hurt relative returns, as did exposure to airline stocks.
Sector allocation also detracted overall and in the majority of sectors, with the most substantial detraction coming from the Fund’s overweight to Consumer Discretionary, the benchmark’s weakest sector for the quarter, and the Fund’s underweight to Energy. Within Energy, an overweight to refiners and an underweight to oil and gas exploration stocks drove relative underperformance. Lack of exposure to Telecommunication Services helped to partially offset those losses, as did exposure to lower volatility stocks such as real estate investment trusts (REITs).
Top individual detractors in the quarter included airline stocks Alaska Air, JetBlue Airways and Spirit Air; refiners PBF Energy, Tesoro and HollyFrontier; and technology companies Seagate Technology and Xerox. Top individual contributors on a relative basis included REIT holdings Senior Housing Properties Trust, Lexington Realty Trust and Franklin Street Properties, as well as Huntington Ingalls Industries and Murphy USA.
LSV Asset Management’s 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


Finding Value in Our Model
While the overall market closed the quarter trading above its historical averages, the Fund’s valuations remained attractive on multiple measures versus averages for its benchmark. The Fund traded at 11.7 times forward earnings, compared to 16.1 times for the Russell Midcap® Value Index; 1.5 times book value, compared to 1.7 times for the index; and 7.4 times cash flow, compared to 11.4 times for the index.
Valuations Stretched
The market environment, in which lower quality and defensive sectors and stocks outperformed, led to the Fund’s relative underperformance this quarter. We believe many such stocks are overly expensive, particularly among Utilities, Consumer Staples and Health Care. However, investors continue to stretch for yield and safety, which has driven up the valuations for these stocks. Historically, we have followed poor relative performance periods with significant recovery in subsequent quarters, although the timing is always unpredictable.
Positioning in Health Care
From a sector perspective, the most significant change was an increase in our exposure to Health Care stocks, from a slight underweight position to an overweight. We added several Health Care names during the quarter, while the sector’s benchmark weight decreased as a result of a rebalance at quarter end. The Fund’s sector exposures are driven by valuations: we overweight those sectors and industries where we find the most attractive stocks from a valuation standpoint, and underweight those where we have difficulty finding cheap stocks.
Murphy USA a Top Performer
During the quarter, we purchased Murphy USA in the Consumer Discretionary sector. The stock ranks high on valuation, particularly on cash flow indicators, and is also attractive on our momentum measures, both price and operating momentum. In addition, the company is buying back shares, which we view positively. Shares advanced nearly 25% for the quarter.

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.