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Mid Cap Value Fund —
Mid Cap Value Fund registers 12-month return of more than 40%
4th Quarter, 2013
"After the surge in equity markets in 2013, the Fund is trading at much higher multiples than a year ago. However, it is still trading at a significant discount to the benchmark. "
– Bhaskaran Swaminathan, Director of Research

The Harbor Mid Cap Value Fund closed out 2013 with a solid advance, outperforming its benchmark for both the fourth quarter and calendar year. The Fund returned 11.99% for the three months ended December 31, 2013, surpassing the 8.56% return of the Russell Midcap® Value Index by 343 basis points, or 3.43 percentage points. For the full year, the Fund recorded a return of 44.06%, well ahead of the 33.46% return of the Russell Midcap® Value benchmark.
The Fund's deep-value approach helped to boost relative performance, notes Bhaskaran Swaminathan, Director of Research for LSV Asset Management, subadviser of the Fund. Cheaper stocks, as measured by metrics such as price/earnings and price/cash flow ratios, outperformed the broader mid cap value universe in both the fourth quarter and calendar 2013, he says.
Swaminathan reports that top individual contributors in the quarter included Valero Energy, Marathon Petroleum, Western Refining, United Therapeutics, Seagate Technology, and Ameriprise Financial. Detractors included USANA Health Sciences, Public Service Enterprise Group, AGCO Corporation, and Lexington Realty Trust.
Looking ahead, Swaminathan points out that equity valuations have become less attractive in the wake of the strong advance by stocks in 2013. He believes, however, that equities still compare favorably to bonds, and he notes that the Fund as of December 31, 2013, still traded at a significant discount to its Russell Midcap® Value benchmark.
Bhaskaran Swaminathan's comments were made in a January 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2013, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2013.

Interview Highlights

Modest earnings gains
As was the case in recent quarters, most of the market advance was a result of higher valuation multiples, while earnings grew only modestly. Deep-value stocks, based on price/cash flow and price/earnings metrics, did well in the quarter, particularly compared to high-yielding and defensive stocks.
Portfolio valuations
After the surge in equity markets in 2013, the Fund is trading at much higher multiples than a year ago. However, it is still trading at a significant discount to the benchmark. The Fund is trading at 12.9x forward earnings compared to 16.3x for the Russell Midcap® Value Index, 1.6x book value versus 1.8x for the value benchmark, and 7.9x cash flow compared to 10.0x for the benchmark.
Deeper-value stocks outperformed
Performance attribution indicates that both sector and stock selection had a positive impact on results in the fourth quarter. Our emphasis on stocks with low price/cash flow and low price/earnings multiples was rewarded even though the value index only modestly outperformed the growth index, as deeper-value stocks within the value benchmark did very well.
Tracking bond yields
The yield of the 10-year U.S. Treasury note is still around 2.9%. If it moves into a range of 3.5% to 4%, you might find some investors starting to favor bonds over equities. But at this point equities are still relatively attractive, in our view, compared to bonds.
Safety margin
If you look at historical data, equity valuations are above the median. They are not at a danger level, in our view, but definitely more expensive than a year ago. It is something we will keep an eye on but it also means that our focus on the cheaper areas of the market should give us a margin of safety. We are quite comfortable with the valuations of our portfolio.

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.