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Mid Cap Value Fund —
Value stocks outperformed growth in the first quarter
1st Quarter, 2016
"Value stocks are looking very cheap, from a valuation perspective, compared to the larger, more growth-oriented names that drove returns in 2015. "
– LSV Asset Management

Driven by concerns over global growth and continued pressure on oil prices, U.S. equities posted double-digit declines through mid-February, before reversing and recovering all or most of the losses by the end of the first quarter of 2016. Actions by central banks and a recovery in oil prices helped fuel the reversal, while economic indicators in the U.S. were mixed; employment reports continued to show job growth, and fourth quarter Gross Domestic Product was revised to 1.4%, but consumer confidence and retail sales were less encouraging.
Against this backdrop, mid cap stocks led U.S. equities, advancing for the first quarter. The S&P 500 was up 1.35%, while small cap stocks, as measured by the Russell 2000® Index, declined -1.52% for the period. Value stocks generally outperformed growth names; among mid cap stocks, value outperformed growth by 3.34%. Within the Russell Midcap® Value Index, Utilities and Materials led advancing sectors, while Financials and Health Care were the only sectors to decline.
The Harbor Mid Cap Value Fund was up 2.70% in the first quarter, while its benchmark, the Russell Midcap® Value Index was up 3.92%, and the Russell Midcap® Index advanced 2.24%. Sector selection detracted from relative returns, particularly the Fund’s underweight to Utilities and lack of exposure to Telecommunication Services. Underweights to Financials and Health Care helped to partially offset those losses. Stock selection also detracted overall. The Fund’s stocks outperformed in the Information Technology and Utilities sectors, but this was offset by poor selection elsewhere, particularly in Energy, Materials and Consumer Staples. Top individual contributors in the quarter included Public Service Enterprise Group, Dupont Fabros Technology and Cummins. Detractors included Regions Financial, Marathon Petroleum and United Therapeutics.
LSV’s Director of Research Bhaskaran Swaminathan’s comments were made in an April 12, 2016 interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through March 31, 2016.

Interview Highlights

Opportunities in Value
The valuation spreads between value and growth are as wide as they’ve been since the late 1990s, particularly based on book-to-market ratios, and we believe the Fund’s valuations continue to remain quite attractive. The Fund trades at 11.7 times forward earnings, compared to 18.3 times for the Russell Midcap® Value Index; 1.5 times book compared to 1.7 times for the index; and 7.5 times cash flow, compared to 11.4 times for the index.
Small and Mid Cap Companies No Longer Trading at a Premium
Historically, if you look at the last 10 or 12 years, mid cap stocks and small cap stocks have typically traded at a bit of a premium to large cap stocks, because the smaller companies tend to have higher growth expectations. That growth premium seems to have kind of disappeared as a result of the underperformance in the small cap and mid cap areas, especially in the value space. At the end of the first quarter, mid cap value stocks were essentially trading on par with large cap value on price-to-forward earnings.
Positioning in Energy
Obviously, some measures of valuation in energy companies certainly look attractive. We didn’t buy or sell a whole lot in that area during the quarter. I think in terms of our model, we do have to see some significant pickup in the fundamentals of these companies. Their earnings have to improve. They have to beat expectations. Analyst forecasts have to be revised upwards. Valuation is certainly a factor. But we need to see a lot more momentum in these areas for the sustainable period, not just for a month or two, before our model will start gravitating towards some of these names.

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