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Mid Cap Value Fund —
Mid cap value shares advanced in Q1, led by defensive sectors
1st Quarter, 2014
"My view is that if stocks are fairly valued to slightly over valued, it makes sense to be in the cheaper areas of the market. "
– LSV Asset Management

U.S. equities advanced in the first quarter of 2014, with shares of mid cap companies returning 3.53%, as measured by the Russell Midcap® Index. By comparison, the Russell 1000® Index, a measure of large cap stocks, returned 2.05%, while shares of small cap companies returned 1.12%, as measured by the Russell 2000® Index.
Value-oriented stocks outperformed their growth counterparts across the capitalization ranges. Within the mid cap universe, the Russell Midcap® Value Index posted a return of 5.22%, while the Russell Midcap® Growth Index returned 2.04%.
In this environment, Harbor Mid Cap Value Fund recorded a return of 4.62% for the three months ended March 31, 2014, trailing its Russell Midcap® Value benchmark by 60 basis points, or 0.60 percentage point. Fund performance was broad based, with all 10 economic sectors in the portfolio posting positive returns.
Defensive segments within the Russell Midcap® Value Index, such as Real Estate Investment Trusts (REITs), Utilities, and Consumer Staples led the market in the first quarter, while deeper-value stocks, typically favored by Harbor Mid Cap Value Fund, failed to keep pace, says Bhaskaran Swaminathan, Director of Research for LSV Asset Management, subadviser of the Fund. Underweighted positions in REITS and Utilities hurt relative performance, he notes. Stock selection was positive in the Consumer Discretionary and Utilities sectors, partially offset by unfavorable selection among Financials, he reports.
Top individual contributors in the quarter included Helmerich & Payne, Trinity Industries, Domtar, Tyson Foods, and Edison International, Swaminathan reports. Detractors in the portfolio included United Therapeutics, GameStop, AGCO, and Ameriprise Financial.
Bhaskaran Swaminathan’s comments were made in an April 9, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2014.

Interview Highlights

Sector positioning
The most significant changes to sector weights during the quarter were increases in Materials and Industrials and decreases in Financials and Health Care. As of March 31, the Fund was overweighted in the Materials, Consumer Staples, and Energy sectors. Those are the areas where we are finding the most attractive valuations. We ended the quarter with underweighted exposures to Health Care, Utilities, and REITs, while all other sectors were within plus or minus 2 percentage points of the benchmark.
Deep-value portfolio
My view is that if stocks are fairly valued to slightly over valued, it makes sense to be in the cheaper areas of the market. As of March 31, the Fund was trading at a significant discount to the Russell Midcap® Value Index. The portfolio was trading at 12.6 times forward earnings compared to 16.7 for the index, 1.6 times book value compared to 1.8 for the value benchmark, and 8.1 times cash flow compared to 10.6 for the benchmark.
Momentum swings
Fluctuations in momentum stocks typically don't have a huge impact on our portfolio because those are not the kinds of stocks we are holding. Our focus is on the deep-value segment of the market and on low turnover. We are very patient investors. That approach usually shields us pretty well from some of the big momentum swings.
Stocks versus bonds
We think the market looks a little bit expensive compared to its historical average but what about compared to bonds? At current yields, bonds still look pretty expensive compared to stocks, in our view. If the yield of the 10-year Treasury note were to increase to around 4% (up from 2.73% at the end of the first quarter), then stocks wouldn't look as attractive compared to bonds. It’s always a relative game.
Mixed data
Markets advanced in the first quarter despite mixed economic data and the start of Federal Reserve’s program to scale back quantitative easing. While the Fed began to taper its bond purchases, new Fed Chair Janet Yellen indicated that policy rates are likely to remain low for some time, which was well received by investors. On the economic front, housing data were weak, unemployment picked up slightly, and fourth quarter GDP growth was revised downward. Some of the weakness was attributed to unusually severe winter weather. However, companies reported strong earnings and consumer confidence numbers continued to rise.

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.