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Small Cap Growth Opportunities Fund —
Tax reform, fundamentals drive strong 2017 for small cap growth
4th Quarter, 2017
"Our focus is on understanding the sustainability of earnings growth for specific companies. We're optimistic about the fundamentals of the portfolio's holdings, and that gives us optimism about the year ahead. "
– Elk Creek Partners, LLC

In December, the U.S. Congress passed highly anticipated tax reform legislation that will lower corporate and small-business tax rates, and lower federal taxes for most households. During 2017, small cap equities generally saw an improvement in earnings growth, driven by healthy revenue growth and margin expansion. During the fourth quarter of 2017, small cap growth stocks, as measured by the Fund’s benchmark, the Russell 2000® Growth Index, posted a return of 4.59%. Within the benchmark, Energy was the strongest performer. Consumer Staples, Consumer Discretionary and Industrials also had strong returns. Only Telecommunication Services declined, though Information Technology and Real Estate advanced slightly but lagged. The benchmark recorded a 22.17% advance for full year 2017, handily outperforming its value counterpart, the Russell 2000® Value Index, which gained 7.84%.
The Harbor Small Cap Growth Opportunities Fund underperformed its benchmark, with a quarterly return of 3.21% and one-year return of 17.62%. For the quarter, stock selection in Health Care and Information Technology detracted from relative performance, while security selection in Consumer Discretionary contributed to relative results.
Elk Creek Partners’ comments were made in a January, 2018 report. Highlights adapted from the report appear below. All comments relate to the quarter ended December 31, 2017, unless otherwise indicated. All references to the year-to-date are for the period January 1 through December 31, 2017.

Interview Highlights


Stock Surge of 2017 Was About More Than "Trump Bump"
We saw surprisingly strong equity performance in 2017, and market conditions were favorable for fundamental active growth managers. Some investors might want to dismiss the stock market rally since so little was accomplished in Washington, at least until tax reform was enacted. Still, there is more to the market move than just hopes of fiscal stimulus. In their small cap strategy report in early January 2018, Barclay’s highlighted that EBITDA growth for the asset class was the strongest since 2014. While they also pointed out small cap valuations rose to a new post-crisis high, we believe that underlying fundamental performance certainly contributed to last year’s move.
Tax Reform Could Be a Particular Boon for Small Caps
We viewed the recently enacted tax reform as the most significant macro level event in the quarter and year. Anticipation of tax reform and the package itself were key drivers for equity markets in 2017. We believe that tax reform could disproportionately benefit small cap stocks, since their tax rates are typically higher than mid and large cap companies.
Fundamentals: The True Long-Term Driver of Performance
We are disappointed with our relative performance for the year. While our first half was relatively strong, our second half lagged, especially the third quarter, which drove the relative gap. We remain confident in our longstanding investment process, and our belief is that over the long run, stock performance will be driven by earnings and business fundamentals.
Valuations Are High Heading into 2018, But Optimism Reigns
Market pundits are consistently citing the high current valuations of equities, and while we believe that sentiment is indeed accurate, we also think that historically low interest rates contribute to current equity valuations. However, the question of whether or not market valuations contract from these levels is not where we are spending our time and energy; rather, our focus is on understanding the sustainability of earnings growth for specific companies. We are optimistic about the fundamentals of the Fund’s holdings, and that gives us optimism about the year ahead.

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.