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Mid Cap Value Fund —
Mid caps pace a strong quarter for U.S. equities
1st Quarter, 2013
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"Deep value stocks performed well in the quarter, which helped the Fund outpace the benchmark. "
– Bhaskaran Swaminathan, Director of Research

U.S. equity markets surged ahead in the first quarter of 2013 with double-digit returns across all capitalization ranges. Mid cap value shares fared especially well, with the Russell Midcap® Value Index posting a return of 14.21%.
The Harbor Mid Cap Value Fund outperformed the index, returning 15.17%. Bhaskaran Swaminathan, Director of Research for LSV Asset Management, subadviser of the Harbor Mid Cap Value Fund, reports that sector positioning and stock selection both contributed to Fund performance.
An above-index weighting in Consumer Staples and an underweighted exposure to REITS had positive impacts on results; Consumer Staples was the best performing sector in the benchmark. Also aiding performance was stock selection in the Energy, Consumer Staples, and Financials sectors. Top contributors in the portfolio included Hess Corp., Valero Energy, and Tesoro in the Energy sector; supermarkets Kroger and Safeway; and CommonWealth REIT. Detractors included Harris Corp., Dillard's, Cliffs National Resources, Domtar, and Autoliv.
Despite strong recent performance, portfolio valuations remain attractive on a historical basis, Swaminathan reports. As of March 31, the Fund was overweight relative to the index in Consumer Discretionary, Consumer Staples, Information Technology, and Financials stocks, while underweight in Utilities, Industrials, and REITS.
Bhaskaran Swaminathan's comments were made in an April 9, 2013, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2013, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2013.

Interview Highlights

Positive trends
Economic news has been trending positively and corporate earnings have continued to improve, albeit at a more modest pace. The primary driver of return, as it was in 2012, has been expanding valuation multiples, as cash, mostly from retail investors, makes its way back into the market. Company fundamentals remain solid with further improvement expected for 2013.
Lower-multiple names
Deep value stocks performed well in the quarter, which helped the Fund outpace the benchmark. Lower-multiple stocks, based on such measures as cash flow, book value, and earnings, did well, and that had a positive impact on our results.
Expanding multiples
Recent above-average returns have been driven primarily by an expansion of valuation multiples as opposed to significant earnings and/or dividend growth. Growth is expected to remain muted in 2013 but in our view valuations are still not terribly challenging.
Value reversal
Value stocks had struggled versus growth since 2007 but we saw a reversal in 2012 and so far this year it seems to be continuing, especially in large cap and mid cap. We are hopeful it will continue because historically when value reverses after a period of underperformance, it tends to do well for several years. The fact that the portfolio is trading at a reasonable discount to the benchmark indicates to us that there should be room for further multiple expansion.
Focus on fundamentals
Correlations in stock performance have declined from their highs in 2011 and early 2012, which means that macroeconomic news has taken a bit of a back seat and attention has returned to fundamentals. As quantitative managers focused very much on fundamentals, we see that as a positive factor for our strategies and for active portfolio managers in general.

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.