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Emerging Markets Equity Fund —
Emerging markets equities post narrow loss in challenging quarter
1st Quarter, 2014
"Emerging markets stocks in aggregate look inexpensive to us. "
– Oaktree Capital Management, L.P.

Stocks of companies based in developing markets lost ground in the first quarter of 2014, with the MSCI Emerging Markets (ND) Index registering a negative return of -0.43%. Only 4 of the 10 economic sectors in the index posted positive returns for the three months ended March 31, 2014. Information Technology and Consumer Discretionary stocks made the biggest positive contributions to index performance.
The Harbor Emerging Markets Equity Fund returned -0.90% for the quarter, lagging the benchmark index. Holdings in the Consumer Discretionary sector were the leading contributors to absolute returns for the Fund, while Financials and Energy names proved to be the biggest detractors. For the five month period from its inception on November 1, 2013, the Fund returned -1.40%, outperforming the index return of -3.31%.
Stocks in developing markets performed relatively well against a backdrop of mostly negative macroeconomic and geopolitical developments during the first quarter, in the view of Tim Jensen, Portfolio Manager of Harbor Emerging Markets Equity Fund. He believes that emerging markets equities are attractively valued and that some of the uncertainties that have been weighing on the market could diminish in the months ahead.
At the end of the first quarter the Fund's biggest exposure relative to the index was in the Consumer Discretionary sector, Jensen notes. The Fund also held overweight allocations in Consumer Staples and Information Technology, while its sector weights in Financials, Industrials, Telecommunication Services, and Utilities were below those of the benchmark. From a country-level perspective, the Fund held overweight positions in China, Brazil, and Russia, while underweights included South Korea and South Africa. Economic sector and country exposures are primarily a result of the investment team's bottom-up, stock-by-stock portfolio construction process.
Tim Jensen’s comments were made in an April 16, 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

Attractive valuations
Emerging markets stocks in aggregate look inexpensive to us. Currencies have weakened over the last year or so; as a result trade deficits have turned for the better in most markets, which we see as a real positive. Expectations are still low and valuations are low. But we think some of the big issues that people have been concerned about are moving in the right direction, and there could be a lot of potential upside as investors start to recognize that.
Bottom-up analysis
Dispersion of returns among individual stocks seemed to pick up late in the quarter. Some companies that had been heavily shorted or had low expectations moved up quickly if they just met expectations or beat estimates by a little, while some of the high fliers that missed got hit really hard. When the market responds to stock-specific results that is usually a good environment for us because we’re focused on bottom-up, stock-by-stock analysis.
China exposure
Our biggest exposure is in China, both absolute and relative to the benchmark. We think a lot of bad news is already priced into the Chinese stocks we own. The economy is definitely slowing in China and the growth of credit is slowing. We are monitoring that very carefully but we still like the stocks we have there. We’re also overweight in Brazil. That market started out very badly in the quarter but finished very strong.
Potential upside
You’re never happy to be down but if had you told me on January 1 that we were going to have as many negative headlines as we did and yet the market would be almost flat on March 31, I would have been pretty surprised. Valuations are relatively low in our view and that may reflect much of the bad news we have already seen. We could be at a stage where, if things go a little bit better than expected, stocks could move up pretty quickly.
Tough market
Russia has been a tough market for us because of geopolitical issues; the flip side is that the names we own are trading at very low multiples. The weaker Ruble actually helps the earnings of most of the companies we own in Russia because they’re geared primarily to exports. As long as there are no sanctions imposing restraint on trade, we particularly like what we have in Russia.

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.