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Emerging Markets Equity Fund —
Fourth Quarter Manager Commentary
1st Quarter, 2019
"As opposed to forecasting themes or trends, our main focus is to follow our bottom-up process to find good quality names, no matter the country or sector, which we believe will perform well over the long-term. "

Economic Overview
Emerging market equities generated strong returns in the first quarter of 2019, although they underperformed developed markets. The rally followed the deep sell-off in global equities in the fourth quarter of 2018 and was triggered by the U.S. Federal Reserve’s (Fed’s) halt to interest rate hikes, reported progress in trade negotiations between the U.S. and China, and Chinese monetary and fiscal stimulus. Credit availability in most markets improved during the quarter. Chinese domestic shares were particularly strong, initially sparked by foreign inflows and then sustained by domestic investors.
Portfolio Review
In the first quarter of 2019, the Harbor Emerging Markets Equity Fund (Institutional Class) returned 12.67%, outperforming its benchmark, the MSCI Emerging Markets Index (ND), which returned 9.91%.
The portfolio’s relative outperformance was driven largely by stock selection in China, Russia, India, and Indonesia, along with our overweight allocation to China. Conversely, stock selection in Brazil and South Africa detracted substantially from relative returns. From a sector perspective, stock choices among Financials, Energy, Consumer Staples, Health Care, Communication Services, and Real Estate contributed positively. On the downside, our underweight exposure to Consumer Discretionary had a negative impact on relative performance.
The broad market rally was encouraging, although we faced a modest style headwind during the first quarter, as growth stocks outperformed their value peers. The Fund benefited from the strong relative performance of Chinese equities, given our significant overweight exposure to that market.
On a relative basis, two Chinese stocks—liquor company Wuliangye Yibin and Guangzhou R&F Properties, a property developer—were among the top individual contributors. Wuliangye Yibin shares rallied strongly during the quarter after the company reported better than expected sales and earnings. The stock also benefited from foreign portfolio inflows and expectations that demand for high-end consumer products will accelerate in China. Guangzhou R&F shares advanced after the company extended its debt profile at lower than expected interest rates. The company also reported better than expected property sales as the Chinese residential property market heated up late in the first quarter.
Two positions based in Russia also bolstered relative returns. LUKOIL, an oil and gas company, benefited from a sharp rally in oil prices. The company has a clearly defined policy for returning excess cash flow to investors, and we believe higher oil prices are likely to lead to greater cash flow generation and therefore larger share buybacks. Sberbank rallied from depressed valuations after reporting strong 2018 results. The market’s concern with further Russian sanction risk seems to have abated somewhat.
Elsewhere, shares of India-based ICICI Bank performed well, given strong execution of its turnaround plan by new management. We believe the bank’s openness about its bad debt exposure and asset resolution progress has supported the share price. Analysts expect profit and asset growth to accelerate going forward.
Conversely, Alibaba, China’s largest internet service portal and e-commerce company, was among the largest individual relative detractors. Though shares of the large index constituent outperformed during the quarter and contributed to the Fund’s return on an absolute basis, our underweight exposure weighed on relative performance. Our underweight was based around valuation concerns and our large, existing overweight exposure to China.
AmorePacific, the South Korean beauty and cosmetics conglomerate, also detracted from relative results. Shares underperformed during the first quarter after reporting lackluster results. Purchases by Chinese tourists are a big driver of the company’s cosmetic sales, but these sales have been mixed due to a slowdown in Chinese visits to South Korea and restrictions on the resale of consumer goods on Chinese e-commerce platforms.
South Africa-based food retailer Shoprite, which reported weaker than expected results due to the slow consumer recovery in South Africa and currency weakness in some of its other African territories, also weighed on relative returns. Shares of South Korea-based steelmaker POSCO, another relative detractor, were pressured by higher than expected costs for iron ore, one of its key raw materials, following iron ore production disruptions in Brazil and Australia. A position in Brazil-based Ultrapar also had a negative impact as shares trailed the market. The Brazilian consumer recovery has been slow, which negatively affected volumes and margins at the company’s fuel distribution unit.
During the first quarter, we added a position in UltraTech Cement, a leading cement producer in India. We believe the company has broad geographical reach within India, some of the most modern cement plants in the country, and a strong distribution network. In our view, the company could benefit from increased infrastructure investment in India, which has the potential to drive revenue growth, increase capacity utilization, and improve margins.
We liquidated Sinopharm, a Chinese pharmaceutical distribution company. The Chinese government is rolling out a pharmaceutical purchasing program that is driving down drug prices, and we believe this tendering program could negatively affect Sinopharm’s revenues and profits.
As opposed to forecasting themes or trends, our main focus is to follow our bottom-up process to find good quality names, no matter the country or sector, which we believe will perform well over the long-term. It is important that we stick to our bottom-up discipline and be certain that each name in the portfolio is performing in line with our expectations.
Our outlook for 2019 remains constructive. In our view, emerging market equities are cheap relative to their developed market peers and historical trading multiples, as well as in absolute terms. The benchmark index ended 2018 at multiples of less than 1.5 times book value and less than 12 times trailing earnings. Our portfolio trades at discounts to the market on both of these measures.
In the U.S., the Fed turned more dovish late in 2018, and market observers removed interest rate hikes from their 2019 outlook. Subsequent Fed communications have continued to indicate easier policy. The U.S. Dollar has been appreciating against the Trade Weighted U.S. Dollar (Broad) Index since 2011, despite a down year in 2017. In our view, most emerging market currencies are undervalued or deeply undervalued, based on purchasing-power-parity measures. During the quarter, the Dollar was stable; we believe weakness in the Dollar would be very positive for international stocks.
The Trump administration softened its China trade rhetoric late in 2018, and the administration has repeatedly touted progress in negotiations. In our view, a trade deal that stops short of ending globalization would reduce uncertainty and allow companies to plan and invest again.
Finally, the Chinese government ended 2018 in a fiscal easing mode and has eased more in the first quarter. Economic data, including the March purchasing managers index figures, are starting to exceed expectations.

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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.