Amid a turbulent global economic environment, the investment team of the Harbor Flexible Capital Fund has placed an increased emphasis on companies based in the United States. Although faced with its own share of issues, the U.S. economy appears to be stabilizing in a number of respects, the team believes. In contrast, they see the continuing sovereign debt crisis in the eurozone as a significant risk for equity markets; consequently the portfolio currently has little direct exposure to Europe.

The Harbor Flexible Capital Fund invests primarily in equity securities and other investments selected for their long-term growth potential. In addition to equities, the Fund may invest up to 40% of its assets in fixed and variable income securities. The Fund has been managed since its inception on March 1, 2011, by Marsico Capital Management, LLC. Munish Malhotra and Jordon Laycob, Portfolio Managers and Senior Analysts with Marsico, are Co-Portfolio Managers of the Fund. They assumed this responsibility July 20, 2012, succeeding A. Douglas Rao.

The Fund registered a negative return of -4.25% for the second quarter, giving back a portion of its gains in the first three months of 2012. By comparison, the Fund's benchmark, the Standard & Poor's 500 Index, returned a negative -2.75% for the quarter. Sectors with perceived defensive characteristics, such as Telecommunication Services, Utilities, and Consumer Staples, were among the best Q2 performers in the U.S. equity market, the Marsico team notes. Compared to the benchmark, the Fund was significantly underweighted in those areas; this had a detrimental effect on performance relative to the index. For the six months ended June 30, the Fund posted a positive return of 11.03% compared with 9.49% for the index.

Certain retailing and health care holdings were among the brighter spots for the Fund during the second quarter. These are companies that the team believes can compound their earnings growth and generate strong cash flows irrespective of the macroeconomic environment.

The Marsico team's comments were made in a July 17, 2012, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended June 30, 2012, unless otherwise indicated. All references to year-to-date are for the period January 1 through June 30, 2012.

We have been tilting the Fund towards companies with more “U.S.-centric” business models and have minimized its direct exposure to the eurozone. The Fund's sector allocations as of June 30 emphasized Information Technology, Consumer Discretionary, and Financials. The Fund had no exposure to the Utilities sector. Sector allocations are primarily a residual of the stock selection process.

It is not difficult to make a case that investors could begin viewing stocks as a better income-producing investment than bonds. Approximately 57% of the constituent companies in the S&P 500 Index currently have dividend yields greater than the 10-year U.S. Treasury note. We think that number is likely to increase as a result of announced dividend increases, new dividends (e.g., Apple), the potential for existing dividend payments to grow, and special dividends. Despite record-high corporate cash positions, dividend payout ratios remain near historically low levels.

The Fund's emerging markets weight represented approximately 2% as of June 30. We still believe that emerging markets will be the driver of global GDP growth on a secular basis. For now, however, given the potential for Europe's sovereign debt problems to dampen the global growth outlook – which would likely have the most acute impact on emerging markets – we have elected to keep our direct exposure to emerging markets at a relatively modest level.

The Fund holds a number of investments with business models that we think are less economically sensitive in nature. These span a variety of industries but share the common characteristic of being able to compound revenues at above-average growth rates regardless of the macro environment. We are favoring companies with strong balance sheets, strong cash flows, high returns on capital, dominant and protected market-leading positions, and a willingness to reward shareholders in the form of dividends and buybacks.

We think investors are paying a significant price for perceived safety in defensive sectors. During the quarter overall valuations for Telecommunication Services, Consumer Staples, and Utilities were at their highest levels since late 2008. Each traded at a significant premium to the overall market despite below-average growth rates.