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Emerging Markets Debt Fund —
EM debt markets post solid advance to start 2014
1st Quarter, 2014
"From a regional perspective Latin America is our largest overweight and that is based on changes that are taking place within the region. "
– Stone Harbor Investment Partners LP

Bonds from developing countries moved higher to start the new year, finishing the first quarter of 2014 in positive territory. Emerging markets debt securities recorded a return of 2.82% for the three months ended March 31, 2014, as measured by a blended index composed of 50% each of the JPMorgan Emerging Markets Bond Index–Global Diversified Index, and the JPMorgan Government Bond Index–Emerging Markets Global Diversified. By comparison, the broad investment-grade bond market returned 1.84%, as measured by the Barclays U.S. Aggregate Bond Index.
The Harbor Emerging Markets Debt Fund returned 2.32% for the first quarter, lagging the index. Dollar-denominated bonds proved to be the best performing sector in the emerging markets debt universe in the first quarter, followed by corporate issues and bonds denominated in local currencies, reports John DiSpigno of Stone Harbor Investment Partners, subadviser for the Harbor Emerging Markets Debt Fund. The Fund outperformed the blended index in the local-currency sector but lagged in the other two.
During the quarter the investment team took advantage of market strength to selectively reduce the Fund's overall exposure to local-currency debt, DiSpigno reports. At quarter end the portfolio had a tactical below-benchmark allocation to the local-currency sector, which the investment team believes may be the most volatile area of the EM debt market in the months ahead. Despite the first quarter gains, DiSpigno notes that the investment team believes that valuations in emerging market debt securities remain at attractive levels.
John DiSpigno’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

Rebound by weak performers
Dollar-denominated sovereign bonds outperformed both local-currency and corporate debt, as all three sectors delivered negative returns in January and then recovered in February and March. The recovery was most pronounced in bonds denominated in local currencies, particularly in Brazil, South Africa, Turkey, and Indonesia. These four countries had been the primary contributors to weak performance of local-currency debt markets in 2013. We reduced our local-currency exposure in each of these countries based on their relative outperformance and our assessments of valuation.
Regional exposures
From a regional perspective Latin America is our largest overweight and that is based on changes that are taking place within the region. Relative to the benchmark we are overweight by about 9 percentage points in Latin America and somewhat underweight in Europe, the Middle East, Asia, and Africa.
Portfolio shifts
Asset allocation changes in March continued in the same direction established earlier in the quarter. We continued to reduce exposure to local-currency debt as currencies and interest rates in several emerging market countries rallied in February and March. We also modestly reduced exposure to corporate debt, particularly in Russia and Ukraine. Proceeds from sales of local-currency and corporate bonds funded additions of hard-currency sovereign bonds to the portfolio.
Rebound in Europe
Although we have reduced allocations to Russia and Ukraine, we have increased our overall exposure to Eastern Europe, based on what we think is a slow and steady rebound in the region. We have added exposure to Hungary and we continue to be selectively looking in the region.
Decision-making factors
Going forward, relative valuations combined with assessments of credit quality at the country and sector levels will remain the most important drivers of our decision-making process and tactical asset allocations. Technical factors such as investor inflows and outflows also will be an important input. While retail investor flows remained volatile during the quarter, institutional investor inflows into emerging market debt increased across all sectors, providing support to EM debt markets.

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.