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Mid Cap Value Fund —
Value names led mid cap rally in Q4
4th Quarter, 2011
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"While valuations moved up as a result of the strong performance in the quarter, the Fund's valuation metrics remain very attractive from a historical perspective. "
– Bhaskaran Swaminathan, Director of Research

Mid cap stocks staged a strong recovery in the fourth quarter of 2011, led by the value-oriented segment of the market. The Russell Midcap® Value Index posted a return of 13.37%, while the Russell Midcap® Growth Index rose 11.24%.
The Harbor Mid Cap Value Fund outpaced its Russell Midcap® Value benchmark in the quarter with a return of 15.91%. Sector and stock selection both boosted Fund performance relative to the index, says Bhaskaran Swaminathan, Director of Research for LSV Asset Management, subadviser for the Harbor Mid Cap Value Fund. Stock selection was particularly strong in the Financial, Health Care, and Technology sectors, he reports, offset in part by unfavorable selection in Consumer Discretionary stocks.
Despite the fourth quarter run-up, value-oriented stocks still traded at attractive valuations entering the new year, Swaminathan says. He notes that value names have lagged the growth-stock segment for the past several years but now could be positioned to continue their outperformance of the overall market in the months ahead.
Bhaskaran Swaminathan's comments were made in a January 12, 2011, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2011, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2011.

Interview Highlights

Hope for sustained recovery
The economically-sensitive stocks are still attractive, in our view. They became a little bit more expensive after the gains in the fourth quarter but relatively speaking we think they're still very attractive. Given the long underperformance of value, we are hopeful that the recovery in the fourth quarter will continue this year and that we'll see a good run for the next two to three years.
Value segment led in Q4
After lagging most of the year, value stocks led the recovery in the fourth quarter. Within the Russell Midcap® Value Index, economically-sensitive sectors such as Materials, Industrials, Consumer Discretionary, and Energy, which had trailed much of the year, led the market. Energy and Materials stocks were up over 20%.
Favorable valuations
The Fund is trading at 9.5x forward earnings compared to 13.7x for the value benchmark, 1.1x book value compared to 1.4x for the benchmark, and 5.5x cash flow versus 8.1x for the index. While valuations moved up as a result of the strong performance in the quarter, the Fund's valuation metrics remain very attractive from a historical perspective.
Cautiously optimistic
Given three years of poor performance, reversion to the mean certainly would be favorable to value stocks going forward. From a valuation perspective, the value segment definitely looks cheaper than it has been historically compared to growth. We think the stocks we are holding are good brick-and-mortar companies, well-managed companies with good balance sheets and good earnings quality. We are cautiously optimistic that this value run will continue.
Takeover targets
We don't have an M&A prediction factor explicitly built into our model. But the kinds of companies we like—attractive valuations, good momentum, good earnings quality, improving margins—are also the kinds of companies that tend to become takeover targets. As economic activity picks up and these stocks begin to recover, I would expect some of them to be potential takeover targets, particularly in the small cap and mid cap segments.

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.