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Convertible Securities Fund —
Convertibles market opens 2015 with Q1 advance
1st Quarter, 2015
"Credit for favorable security selection should go to our analyst team, as their focus on positive cash flow analysis and how that translates into equity valuations paid off in the first quarter. "
– Shenkman Capital Management, Inc.

Convertible bonds generated positive results for the first quarter of 2015, as the BofA Merrill Lynch All US Convertibles Index posted a return of 2.97% for the three months ended March 31, 2015. By comparison, U.S. equities returned 0.95% for the quarter, as measured by the S&P 500 Index, while investment-grade bonds, as measured by the Barclays U.S. Aggregate Bond Index, returned 1.61%.
The Harbor Convertible Securities Fund returned 3.27% for the quarter, outpacing the BofA Merrill Lynch All US Convertibles benchmark. The Fund invests primarily in convertible bonds, which can be converted into common stocks at a predetermined price. Portfolio Manager Ray Condon reports that security selection helped drive the Fund's outperformance in the first quarter, as equities underlying the portfolio outpaced those in the benchmark.
The best performing industries relative to the benchmark were semiconductors, computer peripherals, and real estate, Condon notes. The Fund's lack of exposure to benchmark names Micron Technology and limited exposure to SanDisk helped relative performance. Overweighted positions in self-storage company Extra Space Storage and real estate services provider Forest City Enterprises also boosted returns as both posted double-digit returns. Conversely, the top detracting industries were pharmaceuticals, health services, and Internet software and services. In Pharmaceuticals, relative performance was hurt due to a significant underweight in this, for the most part, deep in the money group, specifically Salix Pharmaceuticals which was taken over by Valeant. Within health services, having no exposure to the long dated (25+ years), 100%+ investment premium Anthem, one of the nation’s largest managed health care companies was the primary reason. Lastly, having no exposure to the long dated (22+ years), 100%+ investment premium Verisign, detracted from performance within Internet software and services.
Ray Condon’s comments were made in an April 15, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2015, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2015.

Interview Highlights


Market conditions
The first quarter saw a continuation of what I would call normalized market conditions, with periods of volatility that provided us with opportunities to rebalance the portfolio. The backdrop was a continuation of weakness in commodities, strength in the Dollar, and continued concern about global growth, all coupled with harsher-than-normal winter weather conditions in the U.S. On the positive side, the quarter also saw the initiation of quantitative easing in Europe and a better-than-expected earnings season led by the Information Technology and Health Care sectors, which propelled a February rally.
Surge of new issues
New issuance, similar to what we saw in most of 2013 and 2014, continued strongly in the first quarter. In fact, it was the strongest first quarter in the U.S. convertibles market since 2008. There were 21 deals totaling $15.9 billion. Redemptions through the quarter totaled just under $9 billion, with acquisitions and debt repurchases accounting for the majority. Assuming that the recent surge of new issues continues on trend, we expect that during 2015, for the first year since 2007, convertible new issues will exceed redemptions after having kept pace for most of the last two years. There is still a big supply/demand imbalance, however, since about $100 billion net was taken out of the market between 2008 and 2011.
Focus on fundamentals
Credit for favorable security selection should go to our analyst team, as their focus on positive cash flow analysis and how that translates into equity valuations paid off in the first quarter. During the previous two years it seemed that some investors in the convertibles market were buying almost everything in sight. Now I think we're starting to see more of a focus on the fundamentals of what drives growth, which has always been a key element of our approach.
Response to higher rates
We expect new issue activity to continue to pick up at any sign of a prolonged backup in either the corporate or high yield calendars, as issuers look to take advantage of opportunities to sell into an apparent supply/demand imbalance. An additional catalyst for new issue activity would be a continued improvement in underlying equities. We also look forward to the potential for higher interest rates, as the convertible market typically does not price off the yield curve; historically, we have tended to see a surge in new issues in the convertibles market after rates are raised.

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 www.harborfunds.com.

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.