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Emerging Markets Equity Fund —
Another challenging quarter for emerging markets
4th Quarter, 2015
"Most of our portfolio's balance sheets are in great shape. And we've got leaders who have been through tough economies before. "
– Oaktree Capital Management, L.P.

While 2015 was a tough year for emerging market equities, the MSCI Emerging Markets (ND) Index ended the fourth quarter slightly up at 0.66%, much improved over the previous three quarters. Most sectors lost ground during the quarter. The Information Technology and Consumer Discretionary sectors were the best performers, whereas Telecommunication Services and Industrials had the worst returns. On a regional basis, returns across all 23 countries were mixed, with Indonesia posting the strongest return by a substantial margin and a majority of markets finishing the quarter down.
The Harbor Emerging Markets Equity Fund performed in line with the benchmark during the quarter, with a return of 0.61%. Stock selection in the Financials sector helped relative performance during the period, as did stock selection and an above-benchmark weight to Information Technology. The Fund generated better than benchmark results in South Africa and China, and off-benchmark exposure to Hong Kong also helped. However, stock selection in the Materials and Consumer Staples sectors dragged on relative returns. On a regional basis, Brazil and Korea were the largest detractors from relative performance, due in large part to stock selection.
Portfolio Managers, Tim Jensen and Frank Carroll’s, comments were made in a January 14, 2016 interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2015, unless otherwise indicated. All references to the year-to-date are for the period January 1, 2015, through December 31, 2015.

Interview Highlights

Investor Sentiment in China
In China, the investor braggadocio we saw in past years has been replaced by investor humility. However, there still seems to be a general belief there that the government should bail out Chinese investors, and that the government is responsible for investors’ losses. The government did step in to buy a large number of stocks and put restrictions on stock sales. The government also limited the ability to sell domestically and so pushed some selling into Hong Kong, which affected the Fund negatively. A lot of decent companies with good balance sheets were hurt in that sell-off.
Drama with the Yuan
The Chinese government has changed the way they fix the price of the currency, the Renminbi. For about a decade, the Renminbi was a one-way trade that was stable to appreciating against the U.S. Dollar. Simply put, the Chinese currency was pegged to the Dollar. The government signaled a shift in August and later announced a basket of currencies that they would like the Renminbi to be pegged against. The important part about the change in psychology is that over the years a fair number of companies had been borrowing in Dollars. China has a $5-600 billion trade surplus. If there were no flows in or out of the country other than trade, then the reserves should have gone up by $500 billion last year. They went down by $600 billion, which means there was either a lot of debt repaid or money that went offshore. In our view, what the Chinese government needs to do now is restore confidence so that capital flight doesn’t accelerate from here. They need to calm the market down.
The Macro Picture
In our view, there's a lot more opportunity for stock picking going forward, but we have to get the stocks right. We have to examine the macro environment across emerging markets, given the China slowdown, currency weakness, and weak commodities. We believe the commodity damage has been done, and we’re looking forward to a little bit of stability. We’ve had five years of an adjustment in China, and in the last 18 months, oil, iron ore, coal, and copper were basically slaughtered. Clearly, this is a problem for the whole world, not just emerging markets.
Seeking Opportunities amid Weakened Currencies
Emerging market economies tend to be very volatile. The better management teams that lead companies in these regions have had to deal with multiple crises over the last 20 years, and those teams have learned to cut costs and manage their balance sheets well. They take advantage of things like a weak currency for exporting. In our view, it is an advantage to start from a weak currency for anyone who exports. Investing in countries and companies after the currency has been weakened provides a tailwind to earnings down the road. We’ll be looking to back companies that we believe have good managements and better balance sheets that we think can take advantage of the world we’re in right now, with very weak currencies. We invested in some companies in South Africa during the fourth quarter at what we believe to be reasonable prices. Going forward, we anticipate that governments in some emerging market countries may enact policies this year that serve to calm their markets.

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.