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Emerging Markets Equity Fund —
Emerging markets post losses, underperforming developed markets
4th Quarter, 2016
"As opposed to forecasting themes or trends, our main focus is to follow our bottom-up process to find good quality names, no matter the country or sector, which we believe will perform well over the long-term. "
– Oaktree Capital Management, L.P.

Emerging markets underperformed their developed market peers in the fourth quarter of 2016. The United States presidential election reversed the positive performance in emerging markets versus developed markets. Trump’s victory triggered a Dollar rally, higher U.S. interest rates and fears that protectionism would hurt emerging markets exporters.
The Peso fell sharply following the election amid concerns over potential NAFTA renegotiations, other trade restrictions and a weaker outlook for future foreign direct investment. China also had a weak fourth quarter on trade concerns and currency depreciation. India underperformed following the government’s surprise decision to demonetize its highest value currency notes. This measure was designed to crack down on unreported income and broaden the tax base, but it disrupted economic activity in the short run. On the positive side, Russia was the best performing emerging market, rallying on higher oil prices after agreeing with OPEC countries to cut production.
Emerging markets funds experienced outflows following the election, erasing much of the positive inflows seen during the year prior to the election. The MSCI Emerging Markets Index (ND) Index generated a quarterly loss of -4.16%, underperforming developed markets by a wide margin. The Harbor Emerging Markets Equity Fund held up better than its benchmark, posting a loss of -2.50% for the quarter. Stock selection in South Korea contributed to relative performance, while stock selection in Taiwan weighed on results. Among sectors, Consumer Discretionary made the largest contribution to relative return, thanks to both stock selection and an underweight. Real estate detracted due to stock selection.
Oaktree Capital Management’s comments were made in a January, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended December 31, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through December 31, 2016.

Interview Highlights

U.S. Election Aftermath
In the wake of the Dollar rally, the prospect of renewed Dollar appreciation could have a negative impact on commodity prices, current account deficit countries and companies with Dollar liabilities, and could potentially encourage capital outflows. Emerging markets exporters would usually benefit from optimism surrounding indications of U.S. pro-growth policies; however, Trump’s anti-trade and protectionist rhetoric overshadowed growth enthusiasm. In terms of what to expect from a Trump presidency, much remains to be seen as companies wait to see which of Mr. Trump’s campaign promises will be implemented.
Value Positioning
The fourth quarter rewarded our portfolio of opportunistic value names. Given current valuations, we have been selecting stocks that we believe could perform well in a better market environment rather than hiding in defensive names that we believe are overpriced and that we might expect to lose less in continued poor markets. We consider it important to stick to our bottom-up discipline and be certain that each name in the portfolio is performing in line with our expectations.
China Advances Despite Volatility
China remained in the emerging markets headlines, ending the period slightly higher despite volatility early in the quarter. Although China had a negative contribution to the portfolio’s return during the quarter, we continue to believe that China-based stocks will grow, though at a more modest pace than in the past. We believe that China offers excellent value prospects. Based on this conviction, the portfolio remained overweight in China versus its benchmark.
We continue to follow our bottom-up process to find good quality names, no matter the country or sector, which we believe will perform well over the long-term. We continue to be optimistic about the long-term prospects for emerging markets. As we’ve noted in previous quarters, emerging market equities currently trade at a low price-to-book value relative to the benchmark index’s long-term average and relative to developed market indexes. Many of the companies in the Fund’s portfolio have strong balance sheets and experienced management teams who have weathered volatile economic environments in the past. Moreover, if the Dollar were to stop appreciating, pressure on the Chinese Yuan and the Mexican Peso would ease and emerging markets could perform better.

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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.