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Emerging Markets Equity Fund —
Emerging markets equities stage Q2 rebound, outpace developed country stocks
2nd Quarter, 2014
"What is going to differentiate countries over the next five years, in our view, is their ability to implement growth-friendly reforms. "
– Oaktree Capital Management, L.P.

Shares of companies based in emerging markets turned in a strong performance in the second quarter of 2014, not only rebounding from a negative territory in the prior quarter but also outperforming their counterparts in developed countries.
After recording a negative return of -0.43% for the first quarter, developing markets stocks advanced 6.60% for the three months ended June 30, as measured by the MSCI Emerging Markets (ND) Index. All 10 sectors in the index moved higher in the second quarter, with the Information Technology, Utilities, and Energy sectors posting double-digit gains. By comparison, the MSCI EAFE (ND) Index, a measure of equities in developed overseas markets, returned 4.09% for the second quarter.
The Harbor Emerging Markets Equity Fund returned 5.58% in the second quarter, lagging behind its MSCI Emerging Markets (ND) benchmark. For the eight-month period from its inception on November 1, 2013, the Fund returned 4.10%, outperforming the index return of 3.07%.
Co-Portfolio Manager Tim Jensen reports that stock selection in Mexico and Taiwan boosted Fund performance relative to the index in the second quarter, while selection in China and India hurt relative performance. From a sector perspective, holdings in the Financials and Materials sectors helped relative performance, while stocks in the Industrials and Information Technology sectors underperformed those in the index.
Top individual performers in the portfolio included Brazilian pension and insurance company BB Seguridade Participacoes, Brazilian oil company Petroleo Brasileiro, Chinese personal computer maker Lenovo Group, Taiwanese chip designer MediaTek, and Chinese online retailer All posted double-digit share price gains. Detractors included China Cinda Asset Management, Chinese auto maker Great Wall Motor Co., and Macau gambling company Galaxy Entertainment Group. Great Wall Motor was sold from the portfolio.
Tim Jensen’s comments were made in a July 16, 2014, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended June 30, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through June 30, 2014.

Interview Highlights

Need for reforms
We had a decade in which developing economies grew very quickly. Some probably grew too quickly and problems were created, whether a shortage of infrastructure or a build-up in debt. What is going to differentiate countries over the next five years, in our view, is their ability to implement growth-friendly reforms. As that plays out, we expect that economic viability will become more differentiated among countries and not as generalized across the whole emerging markets asset class, as we saw in the past. We think that should be a better environment for bottom-up stock picking and that is where we are focused.
Russian exposure
By no means has the situation in Ukraine been resolved, but things calmed down somewhat during the second quarter and Russian stocks bounced back significantly from their early March lows. That helped the Fund because we had between 8% and 9% of the portfolio in Russia for most of the second quarter, which was an overweight position. So that bounce was definitely helpful.
Reasonable valuations
After their bounce in the second quarter, emerging markets equities have gone up a bit in terms of multiples but still are not stretched, in our view. The MSCI Emerging Markets (ND) Index is trading at a little over 1.6 times book value and at about 11.5 times forecast earnings, well below its long-term average.
Exploring opportunities
Investments in China, Brazil, and Russia have gotten a bottom-up push from our analyst teams. Based on multiples, Russia and China are among the cheapest areas in the emerging markets asset class, while Brazil is closer to the average. Our view is that they have gotten out of favor over the last few years and there are now a lot of potentially undervalued opportunities in those three big markets.
Slowing growth in China
Growth expectations have definitely been ratcheted down over the last couple of years. Nobody expects China to grow as fast over the next 10 years as it did over the last 10. I think most consensus expectations are for growth around 7%, trending down towards 5% over the next five to seven years. It may be a slower growth story, but it is on such a large base that 5% on the size of that GDP would still be an enormous incremental increase.

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.