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Mid Cap Value Fund —
Energy shares weak as mid cap value stocks move lower in Q3
3rd Quarter, 2014
"When we look at relative valuations, our view is that value stocks are looking pretty attractive compared to their growth counterparts, and we think the portfolio is well positioned. "
– LSV Asset Management

U.S. equities generated mixed investment results in the third quarter of 2014, as mid cap and small cap stocks lost ground while shares of larger companies managed a modest advance. Mid cap value shares recorded a negative return of -2.65%, as measured by the Russell Midcap® Value Index. The Energy sector, down about 14%, was the weakest performing area as 5 of the 10 sectors in the index had negative returns. The index remained in positive territory on a year-to-date basis, with a return of 8.20% for the nine months ended September 30.
The Harbor Mid Cap Value Fund posted a negative return of -2.59% for the third quarter, slightly better than its Russell Midcap® Value benchmark. The Fund is managed by LSV Asset Management. Bhaskaran Swaminathan, Director of Research for LSV, reports that sector weights had a negative impact on Fund performance relative to the index in the third quarter while stock selection added value. A larger-than-index weighting in the Energy sector and an underweight in Health Care stocks had a negative impact on results. 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. Swaminathan notes that while stock selection was weak among Materials, this was more than offset by favorable investment decisions in Industrials, Financials, and Consumer Staples.
Leading individual performers in the portfolio included biotechnology company United Therapeutics, fertilizer producer CF Industries, Information Technology holdings OmniVision Technologies and Brocade Communications, and department store retailer Kohl's. Among the bigger detractors from performance were Energy sector holdings Energy XXI, Noble, and Ensco; paper producer Domtar; and farm machinery maker AGCO.
Bhaskaran Swaminathan's comments were made in an October 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended September 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through September 30, 2014

Interview Highlights

Mixed performance
U.S. stocks had mixed results in the third quarter as large caps posted a slight gain while mid cap and small cap stocks declined. Geopolitical concerns in the Middle East and Ukraine weighed on global markets, but U.S. macroeconomic data remained positive and merger and acquisition activity helped spur gains among large caps. U.S. automobile and new home sales were both strong in the quarter, and employment numbers continued to improve. The Federal Reserve remained on track to end its bond buying program in October but pledged to keep rates low after the end of the quantitative easing program.
Sector exposures
The most significant changes to sector weights in the Fund during the third quarter were an increase in Financials and a continued decrease in our exposure to Health Care stocks. Health Care was one of the better performing areas for us over the last several years but it doesn't look as cheap as it was. As of September 30, the Fund was overweight in the Energy, Consumer Discretionary, Consumer Staples, and Technology sectors, while underweight in Health Care and Utilities. At the industry level, the Fund was overweight Chemicals, Auto Components, Multi-line Retail, and Insurance, while underweight Metals & Mining and REITs.
Comparing valuations
My view is that valuations for large caps are a bit on the expensive side while small cap stocks, which looked a little expensive earlier in the year, are now looking more attractive after a big decline in the Russell 2000® Index. Overall, we think stocks are still attractive, especially compared to bonds. When we look at relative valuations, our view is that value stocks are looking pretty attractive compared to their growth counterparts, and we think the portfolio is well positioned.
Historical perspective
The portfolio is trading at a discount to the benchmark, which is normal, and the size of the discount is not out of line with what we have seen in the past. I think it is right in the ball park in terms of what we have experienced over time. There have been occasions, like in the early 2000s, when our portfolio traded at an even deeper discount, and that's because the benchmark index was more expensive and a bit more growth oriented. But if you look at the last three to five years, it seems in line. There are small differences but I don't think they're significant.

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

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.