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Small Cap Growth Fund —
The U.S. small cap growth equity market rose in the third quarter
3rd Quarter, 2017
"Given overall low interest rates and inflation versus history, coupled with a stronger earnings outlook, specific stock valuations look attractive to us. "
– Westfield Capital Management Company, L.P.

The U.S. stock market acted similarly in the third quarter of 2017 as it did during the first half of the year—a slow but steady march forward. The advance came despite geopolitical tension, political uncertainty and concerns about the economic impacts of the devastating hurricanes that hit the southern U.S. in August and September. During the quarter, small cap stocks outperformed mid and large cap stocks. Growth stocks outperformed value across the capitalization spectrum; however, this dynamic shifted late in the period, when value outperformed growth. In the U.S. small cap growth equity market, as measured by the Fund’s benchmark, the Russell 2000® Growth Index, Telecommunication Services, a relatively small weighting in the index, performed particularly well. Industrials, Health Care, and Financials also performed well. Conversely, Real Estate lagged the overall benchmark, as did Consumer Staples and Utilities, which are small weightings in the index.
The Harbor Small Cap Growth Fund returned 4.07% during the third quarter of 2017, underperforming its benchmark, which returned 6.22%. Stock selection in Industrials and Health Care detracted from relative performance. In contrast, security selection in Consumer Discretionary contributed to relative results.
Westfield Capital Management Company’s comments were made in an October, 2017 report. Highlights adapted from the report appear below. All comments relate to the quarter ended September 30, 2017, unless otherwise indicated. All references to the year-to-date are for the period January 1 through September 30, 2017.

Interview Highlights

A Generally Upbeat Picture of the U.S. Economy
During the third quarter of 2017, most economic indicators painted a generally upbeat picture of the U.S. economy, as unemployment levels dropped to a 16-year low, consumer confidence remained strong, and the Institute of Supply Management’s Manufacturing Purchasing Managers’ Index reading climbed to levels last seen in 2004. September brought renewed interest in risk assets, with investors seemingly excited about the implications of potential tax reform.
We Added Exposure to More Economically and Rate Sensitive Areas
The U.S. stock market continued to grind higher during the quarter, as corporate earnings started to accelerate across many different economic sectors. We continue to see exciting innovation across Health Care and Information Technology. With global growth accelerating and some signs of wage inflation in the U.S., we believe interest rates finally looked poised to edge higher. U.S. manufacturing and transportation accelerated, and we recently added exposure to more economically and rate sensitive areas. Despite an elevated stock market, we are finding attractive risk/reward opportunities in many cyclical areas of the economy.
We Make Our Decisions Based on Fundamental, Stock-Specific Characteristics
On the margin, we reduced exposure to some recent strong performers and reinvested the proceeds in what we viewed as attractively valued stocks in less crowded areas of the market, like Energy and Materials. As always, we make our decisions based on fundamental, stock-specific characteristics, and we adhere to a strict valuation discipline when identifying investment candidates for the Fund.
Specific Stock Valuations Look Attractive
Even with a stronger economic outlook and less accommodative central banks around the world, money has continued to flow into bond funds. In our view, the majority of investors have not believed in this bull market for the last nine years, and not much appears to be changing from a sentiment standpoint. Given overall low interest rates and inflation versus history, coupled with a stronger earnings outlook, specific stock valuations look attractive to us, and new idea generation remains robust. With the Federal Reserve finally off zero interest rates, we believe stocks are finally following earnings growth. Equity correlations have dropped to 10-year lows, in our analysis, which we believe could bode well for active stock picking going forward.

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