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Convertible Securities Fund —
Convertibles build on late-2012 gains with strong advance in Q1
1st Quarter, 2013
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"After stabilizing over the last several years around the $200 billion mark, the convertibles market is beginning to show signs of real growth. "
– Raymond Condon

Convertible bonds turned in a strong performance to start the new year. The convertible securities market, as measured by the BofA Merrill Lynch All U.S. Convertibles Index, recorded a return of 7.88% for the first quarter of 2013.
The advance followed a solid finish for convertibles in 2012, says Ray Condon, Portfolio Manager of the Harbor Convertible Securities Fund. The Fund invests primarily in convertible bonds, which can be converted into common stocks at a predetermined price. The convertibles market benefited as investor psychology improved further in early January following the political compromise on fiscal cliff issues in Washington, Condon says.
The Harbor Convertible Securities Fund returned 3.57% for the first quarter, trailing the benchmark. Condon attributes the underperformance primarily to the Fund's relatively conservative investment style, which may cause the portfolio to lag the index in periods of strong performance by the broad convertibles market. Industry allocations also detracted from performance in the quarter, he notes.
Credit spreads narrowed in the first quarter, Condon reports. However, he sees room for additional tightening in the months ahead, which could be a positive driver for the convertibles market going forward.
Ray Condon's comments were made in an April 16, 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

Rebalancing opportunities
Given the strength of the equity markets from the onset of the new year, rebalancing opportunities within the portfolio have been limited. However, with macroeconomic concerns still unresolved as we enter another earnings season we expect them to present themselves again. During the first quarter we found some opportunities to realize gains as securities approached our equity targets, while introducing new positions as appropriate.
Convertibles market growth
After stabilizing over the last several years around the $200 billion mark, the convertibles market is beginning to show signs of real growth. Market size at the end of last year was $196 billion; at the end of the first quarter it was $207 billion. Part of that is due to security appreciation but the rest is due to a build-up in the new issue calendar.
Focus on growth
The most important driver going forward, in our view, would be the potential for continued outperformance of equities underlying the convertibles index versus the broad equity market averages. With the near-term reduction in macro market uncertainty, we expect to see the convertibles market continue to transition to a focus on the growth attributes for underlying equities, given our overall view that credit markets will remain stable.
Top performers
The three best industries during the quarter were Health Equipment and Supply, Oil Services, and Conglomerates, accounting for 123 basis points, or 1.23 percentage points, of outperformance. The three worst industries were Retail Specialty, Integrated Telecom, and Telecom itself, accounting for just -2 basis points of negative performance.
Increase in new issues
The first quarter saw a continuation of the pick-up in new issuance activity that we had seen towards the end of last year. It is also notable that we're starting to see growth capital come back to the convertibles marketplace. There were 30 deals priced in the quarter for a total of $9.2 billion. With $6.6 billion of redemptions so far this year, we are continuing to see a reversal of the trend of redemptions exceeding new issues that was in place between 2009 and 2011.

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.