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Mid Cap Value Fund —
Stock selection drove Fund outperformance in Q4
4th Quarter, 2014
"The Technology names in the portfolio are primarily older companies. Although their growth rates are declining, they have strong cash flows, they are buying back stock, and they are beginning to pay more dividends. "
– LSV Asset Management

Shares of mid-sized U.S. companies advanced in the fourth quarter of 2014, with most economic sectors posting positive returns. Mid cap value stocks returned 6.05% for the quarter and 14.75% for the full year, as measured by the Russell Midcap® Value Index. Energy was the only sector to lose ground in the fourth quarter. It was down 26%, reflecting investor concerns over a steep decline in oil prices.
The Harbor Mid Cap Value Fund outperformed the Russell Midcap® Value benchmark with a return of 7.27% for the fourth quarter. The Fund is managed by LSV Asset Management. Bhaskaran Swaminathan, Director of Research for LSV, reports that stock selection was a key driver of returns relative to the benchmark. The Fund outperformed the index in seven of the nine sectors in which it was invested; the Fund had no holdings in Telecommunication Services. An above-benchmark exposure to the Energy sector hurt relative performance, although the Fund's Energy stocks outperformed those in the index. Sector weights are typically a result of the Fund's bottom-up stock selection process, subject to minimum and maximum exposures to sectors and industries, rather than an active element of portfolio strategy. For the full year the Fund returned 14.15%, lagging the index.
Leading individual performers in the portfolio in the fourth quarter included appliance maker Whirlpool, auto parts maker Meritor, discount airline JetBlue Airways, and Financials sector holdings DuPont Fabros Technology and AmTrust Financial Services. Among the bigger detractors from absolute returns were Energy sector holdings Helmerich & Payne, Superior Energy Services, Noble, and Ensco, in addition to Trinity Industries, a provider of products and services for energy, transportation, chemical, and construction markets.
Bhaskaran Swaminathan’s comments were made in a January 13, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2014.

Interview Highlights


News-driven market
In 2013 the market seemed to pay more attention to fundamentals while macro news took a back seat. In 2014, especially toward the end of the year and especially with respect to energy, we saw a return to more of a news-driven market. Historically those kinds of periods tend to be more challenging for active money managers.
Value plays in tech names
The Technology names in the portfolio are primarily older companies. Although their growth rates are declining, they have strong cash flows, they are buying back stock, and they are beginning to pay more dividends. That has made them attractive in our model for quite some time, and we have seen a rotation in that space from growth investors to value investors. We may be a little bit ahead of the curve in terms of getting into these technology companies, and I think we could continue to be overweight there for quite some time.
Market sentiment
When energy prices were going up several years ago investors were worried because they were concerned about inflation, so that was supposed to be negative. Now energy prices are dropping and that's also seen as negative news because people are worried that it may be an indication of weakness in the global economy, although the U.S. economy seems to be doing just fine. My feeling is that investors tend to overreact to these events, and they often underestimate the good news and overestimate the negatives.
Portfolio positioning
The Fund is trading at 12.6 times forward-looking earnings compared to 17.2 times for the Russell Midcap® Value benchmark, 1.6 times book value compared to 1.9 times for the benchmark, and 7.9 times cash flow compared to 11.2 times for the benchmark. The most significant changes to sector weights in the quarter were a decrease in the weight of Consumer Discretionary and Consumer Staples stocks and an increase in our exposure to the Information Technology and Financials sectors.
Weighing valuations
Our stock selection within Energy has been good compared to the benchmark but we are not necessarily adding to it. If an individual stock is still in the buy range we will buy it. If it is in the hold range we will hold it. If it drops out of the hold range we will replace it. At the end of the day we are going to look at the valuations of these companies vis-à-vis those in other sectors and we are going to make decisions based on that.

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.