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Convertible Securities Fund —
Convertibles outpace bonds, post competitive returns with equities in Q2
2nd Quarter, 2014
"Historically the convertible market has been generally non-correlated to rising interest rates. "
– Shenkman Capital Management, Inc.

Convertible bonds continued their strong performance in 2014, posting returns of 5.08% for the second quarter and 9.70% for the six months ended June 30, 2014, as measured by the BofA Merrill Lynch All US Convertibles Index. By comparison, U.S. equities returned 5.23% for the second quarter and 7.14% for the half year, as measured by the S&P 500 Index, while investment-grade bonds returned 2.04% for the latest quarter and 3.93% for the first six months of 2014, as measured by the Barclays U.S. Aggregate Bond Index.
A key driver of convertibles returns over the first half of 2014 was the strong performance of equities underlying the convertible bond market, reports Ray Condon, Portfolio Manager of the Harbor Convertible Securities Fund. He notes that equities underlying the BofA Merrill Lynch All US Convertibles Index outperformed those in the S&P 500 Index for both the second quarter and the first six months of 2014.
The Harbor Convertible Securities Fund returned 2.42% for the second quarter, trailing the BofA Merrill Lynch All US Convertibles Index. The Fund invests primarily in convertible bonds, which can be converted into common stocks at a predetermined price. Condon reports that the Fund's best performing industries in the second quarter were Conglomerates, Industrials, and Retail Specialty, while top performing individual holdings included Trinity Industries, Greenbrier, and Group 1 Automotive. The weakest performing areas of the portfolio relative to the benchmark were Semiconductors, Real Estate, and Health Care Equipment and Supplies.
Condon says that, given its long-term strategy, the Fund typically is underweighted in high-delta securities, or bonds having a close correlation to the price of their underlying equity shares, as well as in convertibles trading well above their conversion rates. This has hurt performance relative to the index, as these have been among the best performing areas of the convertibles market in recent months, he notes.
Ray Condon’s comments were made in a July 15, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended June 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through June 30, 2014.

Interview Highlights


Equity drivers
The story of the first half of the year was the performance of underlying equities. After a brief hiatus in late March and early April, the equities underlying the BofA Merrill Lynch All US Convertibles Index resumed their upwards trajectory to all-time highs. During the second quarter, convertible equities were up 695 basis points, or 6.95 percentage points, versus the S&P 500 Index, up 523. Year to date, convertible equities were up 1,152 basis points versus 714 for the S&P.
Growth attributes
As investors assimilate overall economic and political concerns, we expect to see the convertible market continue to transition to a focus on growth attributes for underlying equities, given the overall stability in fundamental credits. We have been seeing that more and more in the new issue market, where growth companies are coming back to the marketplace.
Focus on earnings
With credit being relatively stable and equities trading at 18 times current earnings and 15 times 2015 estimates, we believe that further appreciation will depend greatly on continued strength in earnings growth. We are expecting some episodic volatility surrounding the current earnings reporting period, but we believe we're well positioned to take advantage of any correction.
Outlook for rising rates
Historically the convertible market has been generally non-correlated to rising interest rates. One reason is that convertibles are of relatively short duration. That's Bonds 101: you want to have short duration in a rising-rate environment. In addition, the primary issuers of convertible securities are mid cap and small cap growth companies – businesses that typically benefit most in an improving economy, when rates are more likely to be rising.
Leading performers
In Conglomerates, the Fund benefited from an overweighted position in Trinity Industries, a diversified manufacturer of transportation and industrial products. The security appreciated 16.4% for the second quarter. In Industrials, an overweighted position in Greenbrier, a supplier of equipment and services to the railroad and related industries, was an advantage. We also benefited in Retail Specialty with an overweighted position in Group 1 Automotive, which continues to benefit from growth in auto sales.

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.