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Convertible Securities Fund —
Despite March correction, convertibles post solid advance for Q1
1st Quarter, 2014
"During the quarter we periodically found opportunities to realize gains as securities approached our targets, while introducing new positions that met our risk/reward criteria. "
– Shenkman Capital Management, Inc.

Convertible bonds recorded solid returns for the first quarter of 2014, outpacing broad U.S. equity and fixed income markets. The convertible securities market posted a return of 4.39% for the three months ended March 31, 2014, as measured by the BofA Merrill Lynch All US Convertibles Index. By comparison, U.S. equities, as measured by the Russell 3000® Index, returned 1.97%, while investment-grade bonds, as measured by the Barclays U.S. Aggregate Bond Index, returned 1.84%.
The Harbor Convertible Securities Fund returned 3.46% for the quarter, trailing the index. The Fund invests primarily in convertible bonds, which can be converted into common stocks at a predetermined price. Portfolio Manager Ray Condon notes that the convertible market's first quarter advance came despite a correction in March in which the BofA Merrill Lynch All US Convertibles Index recorded a negative return of -1.74%. He points out that market volatility typically provides opportunities to rebalance the portfolio.
The Fund's best performing industries relative to the benchmark in the first quarter were biotechnology, conglomerates, and internet software, Condon reports. Leading individual performers included Illumina and Trinity Industries. The portfolio's weakest areas in terms of relative performance were semiconductors, health equipment and supply, and leisure.
Ray Condon’s comments were made in an April 14, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through March 31, 2014.

Interview Highlights

Focus on growth
With the exception of the March correction, our view is that the transition of underlying convertible valuations to a more equity-like condition, which we’ve seen for the last several years, is still in place. As markets begin to assimilate economic and political concerns as we go through this correction phase, we expect to see the convertible market continue to transition to focus on the growth attributes of the underlying equities, especially given the overall stability of the fundamental credit markets.
Portfolio moves
From a portfolio activity point of view, we were busy throughout the quarter. Given the sustained relative strength of equity markets through the greater part of 2013, rebalancing opportunities within the portfolio were limited. However, they did present themselves intermittently throughout the first quarter amid heightened concerns surrounding Ukraine, a potential slowdown in China, and weather-related issues affecting the U.S. economy. During the quarter we periodically found opportunities to realize gains as securities approached our targets, while introducing new positions that met our risk/reward criteria.
Expanding convertible market
The big news in the convertible market, in our view, is the continuing rebirth in the new-issue calendar, and we expect that to continue. New issuance year-to-date stands at 26 deals totaling $9.5 billion, with redemptions at $7.7 billion. New issues over the last 27 months have exceeded redemptions by a total of $2.7 billion.
March correction
March saw the initiation of a much-overdue correction in the convertible market, which we’ve been talking about for several quarters. It was not a real surprise given the performance characteristics of the prior 14 months through February. Equities underlying the convertible index were up 63% over that 14-month period, well ahead of a strong performance by the S&P 500 Index, which was up 35%. On top of that, valuations had become somewhat stretched.
Patient investors
It is rare for us to participate in a new issue. The biggest reason is pricing. When we buy a new security for our portfolios we look for a risk/reward ratio, as measured by our models, of 2 to 1, which is typically not available in new issues. If we find a new security attractive, our normal approach is to be patient and wait for it to reach our price point in the secondary market.

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.