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Emerging Markets Equity Fund —
Volatile first quarter for emerging markets
1st Quarter, 2016
"During the volatility early in the quarter, we really tried to look at every name in the portfolio to understand whether we would be able to stay in those positions. "
– Oaktree Capital Management, L.P.

The first quarter of 2016 was volatile for emerging markets. Initially, emerging market stocks sold off in January, a development triggered by concerns over weakness in Chinese equities, continued commodity price weakness and U.S. Dollar strength. Markets seemed to turn in late January when commodities appeared to hit a near-term bottom, the U.S. Dollar seemed to hit a near-term top and China started to stabilize its currency. Emerging markets were down a bit in February before rebounding strongly in March. The MSCI Emerging Markets (ND) Index ended the quarter with a return of 5.71%. The Materials and Energy sectors were the best performers during the quarter, and Health Care was the only sector to decline. On a regional basis, Brazil posted the strongest return, while Greece’s equity market fell significantly.
The Harbor Emerging Markets Equity Fund underperformed its benchmark during the quarter, with a return of 4.09%. Stock selection in the Energy sector detracted from relative performance, as did stock selection and an overweight position in Consumer Discretionary. Regionally, China significantly hindered relative results, primarily due to stock selection. In contrast, stock selection and an overweight position in the Materials sector contributed significantly to relative returns. Off-benchmark exposure to Hong Kong and stock selection in Mexico also helped relative results.
Portfolio Managers Tim Jensen and Frank Carroll’s comments were made in an April 18, 2016 interview. Highlights adapted from the interview appear below. All comments relate to the quarter ended March 31, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through March 31, 2016.

Interview Highlights


Evaluating the Portfolio
During the volatility early in the quarter, we really tried to look at every name in the portfolio to understand whether we would be able to stay in those positions. We asked ourselves, ‘Do the companies have strong enough balance sheets? Were they generating cash flows? Were they doing the right things at the company level so they could get through a slower environment?’ We’ve been pretty careful to own companies that we think have strong balance sheets and that could withstand more volatility should we see it. We like that we’re in some more cyclical sectors, but we also own companies we think are leaders that we believe can do well off of what we view as oversold levels in January.
Positioning in China
We own China Shenhua Energy, an electricity generator and coal company in China. It’s partly a coal business, and coal has been a disaster globally. But we think the company is the lowest-cost producer in China, is the market leader, and has the best balance sheet. The company is cutting costs and capital investment, and it is generating a lot of free cash flow, even with really depressed coal prices. So, if anything were to change for the better, we think there would be a lot of upside potential for the company’s earnings expectations.
Positioning in Mexico
Mexico-based CEMEX, a cement company, gave us trouble in January because it is fairly levered and exposed to U.S. Dollar weakness. It has U.S. Dollar-denominated debt, and it has revenues in Mexican Pesos, Euros and a couple of other currencies. We went through the company’s cash flows, and we saw very little debt amortization that CEMEX needs to get done over the next couple of years. The company was able to raise money pretty cheaply in March and push out what little bit of amortization it had, and the stock rallied late in the period.
An Overweight Position in Brazil
In Brazil, we believe officials need to rein in spending on pensions and health care and get the primary budget back into balance. We believe what happened for President Dilma Rousseff in recent years was part bad luck, as commodities fell and the government had less revenue, and part bad management, as she spent a ton of money to get re-elected, the budget blew up and the country started to run a deficit before interest expenses. With the recent move to impeach the president, the country has a real opportunity to tighten up federal spending, in our view, and restore some confidence. The Brazilian equity market rallied during the quarter on the notion that the country would be able to push through some reforms and stabilize government spending. Hence, we’ve had an overweight position in the market, because we thought there was more upside potential if things started moving in the right direction. We sold some holdings over the quarter because the market had moved up a lot, but we want to be invested there and see the situation play out.

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 www.harborfunds.com.

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.