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Emerging Markets Equity Fund —
Emerging markets equities post Q4 decline, hurt by weakness in Energy and Materials sectors
4th Quarter, 2014
"When beneficiaries of cheaper oil are getting hurt as much as those who are harmed, that suggests to me that you're in a market that is being driven more by macroeconomic worries than by fundamental, bottom-up stock selection. "
– Oaktree Capital Management, L.P.

Worries over weak global growth and falling energy prices took their toll on emerging markets stocks in the fourth quarter of 2014. The MSCI Emerging Markets (ND) Index recorded a return of -4.50% for the quarter, with only 2 of its 10 economic sectors posting positive returns. Energy, down 24%, and Materials, off 12%, were the weakest performing sectors in the index. The Financials and Information Technology sectors, each with a gain of less than 2%, were the only areas of the index not to lose ground.
The fourth quarter decline pushed emerging markets equities into negative territory for the full year, as the MSCI Emerging Markets (ND) Index posted a return of -2.19% for the 12 months ended December 31, 2014. Emerging markets stocks nonetheless outperformed the -4.90% return of their developed-market counterparts for the full year, as measured by the MSCI EAFE (ND) Index.
The Harbor Emerging Markets Equity Fund posted a return of -5.87% for the fourth quarter, trailing its MSCI Emerging Markets (ND) benchmark. Portfolio Manager Tim Jensen reports that holdings in China and Brazil detracted from Fund returns relative to the index in the fourth quarter. From a sector perspective, stock selection in the Financials sector helped Fund returns relative to the benchmark, while holdings in the Materials and Telecommunication Services sectors underperformed those in the index. For the full year, the Fund returned -5.96%, trailing the index.
The Fund's top individual performers in the fourth quarter included China Pacific Insurance, Industrial & Commercial Bank of China, South Korean smartphone maker Samsung Electronics, Taiwan Semiconductor, and South Africa-based media company Naspers. Brazilian companies were among the bigger detractors from absolute returns, including oil producer Petrobras, online retailer B2W Companhia Digital, and mining company Vale. Other major detractors included Moscow-based telecom operator Mobile TeleSystems, which was sold from the portfolio, and Chinese lubricants maker Tianhe Chemicals Group.
Tim Jensen’s comments were made in a January 15, 2015, interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended December 31, 2014, unless otherwise indicated. All references to year-to-date are for the period January 1 through December 31, 2014.

Interview Highlights

Benefits of cheaper oil
About two-thirds of the market cap of emerging markets resides in countries that are net importers of oil. In some of those countries, falling oil prices should be positive from both a trade balance and a government spending point of view. Some of the countries subsidize when oil prices get too high and when those subsidies aren't needed, the government balance improves. As an indication of how disorderly the markets were in December, India and Thailand, two of the bigger beneficiaries of falling oil prices, were down, I believe, 6% and 8%, respectively. When beneficiaries of cheaper oil are getting hurt as much as those who are harmed, that suggests to me that you’re in a market that is being driven more by macroeconomic worries than by fundamental, bottom-up stock selection.
Impact on Russia
Russia was sort of ground zero for a lot of the problems in the fourth quarter. The sanctions have closed bond markets to Russian companies trying to roll over debt, which put pressure on the currency. Russia also is very dependent on oil exports, so it got hit very hard when oil prices fell. Our exposure in Russia hurt us in terms of absolute performance, although it didn’t hurt us relative to the benchmark.
Industry consolidation
We added Anhui Conch Cement, one of the leading cement companies in China. We think the government is going to allow that industry to consolidate, basically to take out some capacity and take out some cost. We think there could be a lot of upside to margins as that happens. It has started to happen already; there have been a few deals. We are very positive about that name. We added it to the portfolio in November after meeting with their management in China.
Upside potential
We think the three companies we have in Russia are very interesting. In a weak-ruble environment, even with oil prices down, Lukoil generates free cash flow. It has a very strong balance sheet with no significant debt rollovers coming up. If oil prices should recover a bit, it should be geared to benefit. We also own a Russian fertilizer company, PhosAgro, and we own Magnit, the leading retailer. They sell in a number of lower and mid-price formats and they have been taking market share. Magnit has been growing same-store sales far above the inflation rate and is still growing its network. We like those three names a lot. We think there is a lot of upside.

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.