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Convertible Securities Fund —
Convertibles conclude 2014 with modest return for Q4
4th Quarter, 2014
"We're very optimistic going forward relative to the potential for new names in the portfolio. "
– Shenkman Capital Management, Inc.

Following a third quarter decline, convertible bonds managed a modest advance for the final three months of 2014. The convertibles market, as measured by the BofA Merrill Lynch All US Convertibles Index, posted a return of 1.29% for the fourth quarter, partly offsetting its -1.61% return for the prior three months. For the full year, the index returned 9.33%. By comparison, U.S. equities returned 4.93% for the fourth quarter and 13.69% for the year, as measured by the S&P 500 Index, while investment-grade bonds, as measured by the Barclays U.S. Aggregate Bond Index, returned 1.79% for the latest quarter and 5.97% for the year.
The Harbor Convertible Securities Fund returned -0.51% for the fourth quarter and 2.55% for the year, 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. Portfolio Manager Ray Condon reports that the positive performance of the convertibles market in 2014, and its outperformance relative to the Fund, were driven in large part by strong gains posted by deep in-the-money securities, or bonds trading well above their conversion price. The Fund typically takes profits in such securities as they become more equity sensitive after reaching their conversion prices as part of its overall strategy aimed at achieving attractive risk-adjusted returns while at the same time protecting principal investments.
With respect to industry positions, Condon reports that the Fund's lack of exposure to the food, miscellaneous energy, and diversified metals and mining industries helped returns relative to the index for the year. Conversely, below-index positions in semiconductors, health care services, and airlines hurt relative performance. The Fund had no exposure to airlines, which traded higher in response to falling oil prices.
Ray Condon’s comments were made in a January 14, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2014.

Interview Highlights

Performance drivers
This past year was almost a replay of what we saw in 2013, where a handful of in-the-money stocks, dominated by technology and biotechnology, distorted the returns in the index. About 25% of the market, trading effectively without any bond characteristics, at or above their conversion prices, contributed over 75% of the index return. That segment was up 31.7% for the year, more than accounting for the difference between ourselves and the index. That’s an area where we do not invest because the security is a virtual equity at those levels.
Wider spreads
Yield spreads widened dramatically. From a low of 391 basis points on June 23 it peaked at 629 before ending the year at 564. Our portfolio is tilted more towards the bond side of the convertible curve, so with spreads widening dramatically bond floors went lower and security prices moved in that direction as well. On top of that, we also were impacted by the dramatic move in energy prices.
Opportunities to add
We’ve had a robust new-issue calendar and we added over 40 new names to the portfolio. During the correction phase throughout the fourth quarter we had many opportunities to add names at or near our optimum entry point, which we would not have been able to do otherwise. We’re very optimistic going forward relative to the potential for new names in the portfolio.
Transition point
From a big picture point of view, I look back at the third and fourth quarters relative to what we’ve been through the previous several years and I think of it as a transition point in the market. I think for the first time in four or five years credit matters again. That is really key to us because it gives us opportunities to buy bonds that we wouldn’t have a chance to do otherwise. On top of that, a return of volatility should favor our strategy of rebalancing the portfolio on a dynamic basis. We think of volatility as our friend, especially in names where we set a price point that we were not able to achieve over the last two years. We are looking forward to multiple opportunities to take advantage of that, on both the buying and also on the realizing-gains parts of our strategy.

Performance data shown represents past performance, which is no guarantee of future results. Current performance may be higher or lower than the past performance data shown. Investment returns and the value of an investment will fluctuate, and an investor's shares, when sold, may be worth more or less than their original cost. You can obtain performance data current to the most recent month-end (available within seven business days after the most recent month-end) by calling 800-422-1050 or visiting

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.