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Mid Cap Value Fund —
Fourth Quarter Manager Commentary
1st Quarter, 2019
"Despite the first-quarter rally in equity markets, the Harbor Mid Cap Value Fund continues to trade at attractive valuations relative to the benchmark and relative to history. "

Economic Overview
U.S. equities rebounded in the first quarter of 2019, nearly reversing the double-digit loss from the fourth quarter of 2018. The S&P 500 finished the first quarter up 13.65%, the best first-quarter return for the index in more than 20 years. Higher interest rates, trade tensions, and slower growth weighed on markets in 2018. However, some of these concerns were mitigated in the first quarter. On the monetary policy front, the U.S. Federal Reserve (Fed) took a more dovish stance in comments and held rates steady, with a target range for the federal funds rate of 2.25%-2.50%. The Fed indicated that there will be no additional interest rate hikes in 2019, a reversal from comments in December, when the Fed signaled two additional interest rate hikes in 2019. On the trade front, expectations rose that the U.S. and China would come to some agreement on their trade dispute. While earnings growth is expected to slow in the U.S., corporate earnings are still expected to grow in the high single-digit range. In addition, the overall U.S. economy continues to grow at a healthy pace, particularly compared to other developed markets. Mid-cap stocks outperformed small- and large-cap stocks over the quarter, as measured by Russell indices, while value stocks lagged growth stocks across all market-cap ranges. From a sector perspective, each of the eleven broad S&P 500 sectors posted gains over the quarter. Information Technology, Real Estate, and Industrials outperformed, while Health Care, Financials, and Materials lagged.
Portfolio Review
In the first quarter of 2019, the Harbor Mid Cap Value Fund (Institutional Class) returned 12.47%, underperforming its benchmark, the Russell Midcap® Value Index, which returned 14.37%.
While expectations that the Fed would hold interest rates at low levels provided a boost to the overall market, the impact was not positive for value stocks, and deep value stocks, in particular. Absolute and relative performance was strong to start the year, as the deeper value stocks that struggled in 2018 recovered somewhat, and the Fund outperformed the value index in January. However, this trend reversed late in the quarter, after dovish comments from the Fed in March: value stocks lagged, and investors flocked to lower-risk, defensive stocks. That had a negative impact on the Fund’s relative performance, as the Fund is underweight defensive stocks, given their excessive valuations. Despite the first-quarter rally in equity markets, the Fund continues to trade at attractive valuations relative to the benchmark and relative to history.
Poor stock selection largely accounted for the underperformance for the quarter, particularly among the Energy, Industrials, and Consumer Discretionary sectors. Within Energy, our underweight to oil and gas exploration stocks and overweight to refiners, which lagged as oil prices climbed, had a negative impact on results. In the Industrials sector, our stock selection among the machinery, heavy trucks, and airlines industries detracted. Conversely, a combination of a favorable underweight and stock choices in Communication Services, the benchmark’s weakest-performing sector, was the largest contributor to relative performance. The Fund’s overweight to Information Technology and underweight to Utilities also added value, as did stock selection in Consumer Staples.
Kroger, a long-term holding in the Consumer Staples sector, was among the largest relative detractors during the quarter. Kroger posted disappointing fourth-quarter earnings and reduced guidance for 2019, and the stock was down more than 10% on the news. Goodyear Tire & Rubber also declined by approximately 10% after reporting disappointing fourth-quarter results. Industrials holding United Continental Holdings and Juniper Networks, a position in Information Technology, were also among the most significant detractors. The Fund’s underweight to oil and gas exploration & production and oil and gas transportation companies had a negative impact on performance, as shares of Williams Companies, Inc. and Hess Corp. – both top five index weightings in the industry – surged more than 30%; neither company was owned in the Fund. Insurance holdings Everest Re and Universal Insurance Holdings also detracted.
In contrast, the Fund’s top contributors included Information Technology holdings Lam Research and Xerox. Semiconductor equipment stocks, including Lam Research, rebounded after struggling in 2018. Xerox was one of the Fund’s top-performing stocks, gaining more than 60% after beating fourth-quarter earnings expectations and guiding higher for 2019. Spirit AeroSystems in the Industrials sector, and Materials holding Domtar also added value. The Fund’s underweight to CenturyLink, whose shares were down 20%, and lack of exposure to PG&E—the utility declined another 25% after filing for bankruptcy in January—also contributed on a relative basis.
At the end of the first quarter, the Fund remained underweight in the Health Care, Utilities, and Real Estate sectors. It was overweight Consumer Discretionary, Financials, and Information Technology stocks. The Fund’s sector exposures are driven by valuations, as we will overweight sectors and industries where we find the most attractive stocks from a valuation standpoint and underweight those sectors and industries where we have difficulty finding cheap stocks. Changes in sector weights relative to the benchmark are gradual, given the Fund’s low turnover. During the first quarter, we reduced the Fund’s weight in the Energy sector, and the Fund is now also underweight Energy stocks. Within Energy, we sold EnCana, a Canadian oil and gas exploration company that had acquired another Fund holding, Newfield Exploration.
While the Fund is near the maximum overweight to Consumer Discretionary stocks, and we find many more attractive stocks in the sector, we reduced the Fund’s weight there as well. We sold Murphy USA and AutoNation, and reduced exposure to restaurant operator Brinker International. Murphy USA, which operates a chain of retail gas stations across the U.S. and was a 2013 spin-off of Murphy Oil, is no longer highly ranked on several valuation measures, particularly earnings measures. In addition, the company does not pay a dividend, although it has had a history of buying back shares. Long-term past performance has been strong, which reduced the rank of the stock in our model.
We increased our exposure to Industrials and Materials in the quarter, establishing new positions in Textron, International Paper, and Silgan Holdings. Textron, an aerospace and defense industry firm engaged in aircraft, defense, and industrial businesses, is attractive on multiple indicators of value, including price-to-earnings, price-to-cash flow, and price-to-book measures. We believe the company is generating strong cash flow, and while it does not pay a high dividend, the company is aggressively buying back shares at current prices, which we view as positive sign. Both price and operating momentum are strong, in our view, as the stock price has started to improve over the last three months. Our measures of operating momentum, including earnings growth, sales growth, and margins, have shown significant improvement.
While we do not develop an outlook or use any macroeconomic forecasts in our investment process, we can comment on the relative attractiveness of the portfolio. The Fund continues to trade at attractive valuations on multiple measures relative to benchmark averages. The Fund traded at 8.8 times forward earnings, compared to 14.6 times for the Russell Midcap® Value Index, as well as 6.6 times cash flow, compared to 10.0 times for the index.

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.