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Convertible Securities Fund —
The U.S. convertible securities market generated positive results in 2016’s fourth quarter
4th Quarter, 2016
"Looking forward, prospects for convertible securities appear positive. "
– Shenkman Capital Management, Inc.

The U.S. presidential election signaled anticipation of a more business-friendly environment for U.S. companies, with a consequent boost in the economy. The U.S. Federal Reserve’s (Fed’s) decision to re-initiate a gradual rise in interest rates indicated a shift from a multi-year dependence on monetary stimulus to a greater focus on the outlook for growth through fiscal policy. The continued stabilization of energy prices, buoyed by Organization of the Petroleum Exporting Countries (OPEC) members’ agreement to limit production, removed some uncertainty from the Energy sector, at least for the time being. In this environment, the BofA Merrill Lynch All US Convertibles Ex Mandatory Index returned 2.61% for the fourth quarter of 2016. The broad stock market, as measured by the S&P 500 Index, returned 3.82%. Investment-grade bonds, as represented by the Bloomberg Barclays U.S. Aggregate Bond Index, posted a return of -2.98%.
The Harbor Convertible Securities Fund generated a return of -0.80%, underperforming its benchmark, the BofA Merrill Lynch All US Convertibles Ex Mandatory Index. The Fund invests primarily in convertible bonds, which can be converted into common stock at a predetermined price.
Shenkman Capital Management’s comments were made in a January, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended December 31, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through December 31, 2016.

Interview Highlights

We Tend to Avoid the Most Equity-Sensitive Sectors of the Convertibles Market
A key feature during the quarter was a rather sudden and substantial rotation in the underlying equities of the convertible securities market’s two largest sectors—out of Health Care and into Information Technology. In Information Technology, the software industry experienced weakness. In contrast, the semiconductors industry, one of the most equity-sensitive segments of the convertible securities market, benefited from the sector rotation. As a matter of style, we tend to underweight or avoid convertible securities of this type, as they have little to no bond characteristics and are closely correlated with equity risk and volatility. It is worth noting that the sector rotation bias that began and was most prominent in October saw a leveling out and the beginnings of a turnaround in December. We believe our continued focus on fundamental analysis will reassert itself as we enter 2017, especially if the market, as we expect, generates periods of volatility.
We Continued to Diversify Through Selective Purchases
During the fourth quarter, we continued to diversify the portfolio through selective purchases in the new-issue market. In addition, similar to the prior two quarters, we took advantage of benign market conditions with an eye toward enhancing optionality and swapped into longer dated tranches of several core holdings.
We Are More Constructive on the Convertibles Market
At the end of 2016, we are more constructive on the convertible securities market going forward than we were at the start of the fourth quarter, with the U.S. presidential election, the OPEC production agreement and the Fed’s interest rate hike behind us. We are certainly more constructive than at the start of 2016, given the uncertainties at that time, such as the effects of the first Fed rate hike in nearly a decade in December 2015, a looming economic slowdown in China, questions about whether the European Central Bank would initiate monetary stimulus efforts and continued weakness in energy prices.
We Expect the Market is Likely to Favor More Balanced Convertible Securities Going Forward
Looking forward, prospects for convertible securities appear positive amid a growth-oriented equity environment, a steady credit environment, the convertible securities market’s historical non-correlation to rising Treasury rates, increased new issue activity and expectations for episodic periods of volatility, which we believe should enhance the focus on positive risk and reward characteristics. We believe the market is likely to favor more balanced convertible securities going forward, those with a positive credit profile, as we enter a period of higher interest rates, with potential intermittent periods of volatility we believe will place a premium on risk versus reward.

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