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Small Cap Growth Opportunities Fund —
Small cap growth stocks rebound in Q4 as most sectors gain ground
4th Quarter, 2014
"It is our view that returns from here are going to be driven primarily by earnings rather than by getting a lot of contribution from expanding multiples. "
– Elk Creek Partners, LLC

After losing ground in the third quarter, small cap growth stocks bounced back with a solid performance for the final three months of 2014. The Russell 2000® Growth Index, a measure of smaller, growth-oriented companies, returned 10.06% for the fourth quarter, more than offsetting a return of -6.13% for the prior three-month period. The fourth quarter advance was fairly broad based, with 6 of the index's 10 economic sectors posting double-digit gains while only the Energy and Utilities sectors recorded negative returns.
The Harbor Small Cap Growth Opportunities Fund returned 7.34% for the fourth quarter, trailing the index. The Fund began operations February 1, 2014. In the 11-month period from its inception through December 31, the Fund returned 8.95%, outpacing the 7.46% return of the Russell 2000® Growth benchmark.
Portfolio Manager Cam Philpott reports that stock selection in the Health Care sector helped Fund performance in the fourth quarter relative to the benchmark index, while returns among Information Technology holdings lagged those in the benchmark. A smaller-than-benchmark exposure to the weak-performing Energy sector also aided relative performance. Sector allocations in the portfolio generally are a result of individual stock selection choices rather than an active component of investment strategy.
Health Care stocks Cerus, ExamWorks, and Volcano were among the leading contributors to absolute returns for the portfolio, along with Industrials holdings WageWorks and On Assignment. Volcano, a U.S. maker of medical-imaging products, agreed to be acquired by Netherlands-based electronics conglomerate Philips. Volcano's shares rose 57% during the quarter before being sold from the portfolio. Among the bigger detractors from performance were Information Technology names Aruba Networks, Shutterfly, and Power Solutions International, Industrials sector holding H&E Equipment Services, and Goodrich Petroleum in the Energy sector.
Cam Philpott's comments were made in a January 12, 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

Focus on earnings
The backdrop is similar to a year ago in that we believe that returns are going to be broadly a function of earnings. We don’t see stretched valuations; we’re not nervous about where the portfolio holdings are trading. It is our view that returns from here are going to be driven primarily by earnings rather than by getting a lot of contribution from expanding multiples.
Impact of cheaper oil
We saw some relative underperformance in the fourth quarter from our Industrials companies, and I think that was due at least in part to worries about growth rates in companies that have oil and gas exposure. Our view is that the drop in energy prices could have more of a stimulative effect for businesses than a headwind to the broader economy.
Technology names
Technology historically has been a strong source of performance for us but it was an area where we underperformed in the fourth quarter. Sometimes that happens, where stocks just don’t perform well over the very short-term. But we feel good about how we’re positioned in that sector and we feel that they can be good stocks for us as we look out into 2015.
Biotech risks
When you look at attribution for the fourth quarter, our overall Health Care positioning was good, although we did have an underweighted exposure to biotechnology. Our view is that a reliance on clinical trials and FDA approvals can make for a highly risky business case; when a biotech business has a disappointment and it doesn't have commercial revenues, the result is often a sharp correction in the stock price.
Fundamental analysis
When markets don’t differentiate, for example between companies that have a little oil and gas exposure versus those with a lot of oil and gas exposure currently, it generally is not a good environment for us. As active managers – who historically have added value by differentiation – we need the market to appreciate a differentiation. In the fourth quarter, there was not as much differentiation as we would have expected, but experience suggests that over time the earnings numbers themselves will eventually drive investor attention.

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.