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Diversified International All Cap Fund —
International equity markets were flat overall during the third quarter
3rd Quarter, 2018
"The near-term growth outlook remains positive, and companies have continued to exceed market expectations. "
– Marathon Asset Management LLP (Marathon-London)

The developing trade war between the U.S. and China, growing evidence of European economic weakness and ongoing U.K. Brexit negotiations with the European Union collectively weighed on global equity market performance toward the end of the third quarter of 2018. This performance offset a relatively strong start to the quarter, particularly across many developed international markets, following strong corporate earnings results. Japan was a relative bright spot in U.S. Dollar terms, largely due to Japanese Yen weakness. Emerging markets generally declined during the quarter, as they have during most of the year-to-date period, with U.S. Dollar appreciation, trade disputes and geopolitical risks in markets like Brazil and Turkey weighing on sentiment.
During the quarter, non-U.S. equities, as measured by the Fund’s benchmark, the MSCI All Country World Ex. U.S. (ND) Index, had a return of 0.71%. The Harbor Diversified International All Cap Fund performed in line with its benchmark, with a quarterly return of 0.71%. An underweight position in China benefited relative performance, as did stock selection in some European countries, including Italy and Germany. Conversely, the U.K. hindered relative results, due to security selection and an overweight position. From a sector perspective, stock selection in Information Technology contributed to relative performance, while security selection in Consumer Staples detracted.
Marathon-London’s comments were made in an October, 2018 report. Highlights adapted from the report appear below. All comments relate to the quarter ended September 30, 2018, unless otherwise indicated. All references to the year-to-date are for the period January 1 through September 30, 2018.

Interview Highlights

International Equity Markets Look Reasonably Valued
After some relative weakness during the third quarter of 2018 and year-to-date, international equity markets look reasonably valued to us, as the near-term growth outlook remains positive and companies have continued to exceed market expectations. There remain, however, geopolitical risks in Europe, while the U.S.-initiated trade dispute is becoming increasingly unsettling for both developed and developing international equity markets.
European Corporate Balance Sheets Are Generally Strong
European equity markets have recently underperformed global markets due to fears of an economic slowdown, trade wars and the effects of Brexit. We believe European equity markets are reasonably priced compared to other global equity markets, while the earnings growth outlook remains positive and corporate balance sheets are generally strong.
Progress on Governance Remains Impressive in Japan
In Japan, we believe signs that long-term Japanese government bond yields may break higher could trigger two strong reversals to help overturn Japan’s deflationary sentiment. We believe these reversals could be 1) a multi-decade asset allocation shift from risk and equity into fixed income assets and cash; and 2) a move toward clear domestic leadership of the equity market, focused on interest rate-sensitive securities and governance. Progress on governance remains impressive, in our view, and, while political uncertainty may increase going forward, signs of meaningful change in a broad range of related areas are structurally rooted in social and generational change.
Slowing Economic Growth in Emerging Markets Is an Opportunity
In emerging markets, slowing economic growth is an opportunity for companies to reassess their capital allocation policies, as well as the market structures in which they operate. We believe improvements in profitability and cash generation can more than make up for slowing economic growth. As always, we believe emerging market investors should continue to be disciplined with regard to valuation.
Resolution of Trade Agreements A Positive Outcome for Canadian Companies
The Canadian economy had been boosted by higher oil prices and has benefited from U.S. economic strength. We believe the resolution of trade agreements with the U.S. is a positive outcome for Canadian companies. Canadian households, however, are much more indebted than their U.S. counterparts; therefore, the country’s central bank faces a careful balancing act. Some trends seen in U.S. equity markets have also been apparent in Canada, with some growth stocks highly valued, particularly as there is something of a scarcity factor for Canadian investors. The exuberance about the cannabis market, however, indicates to us that some investors are reaching too far for return. The Fund’s holdings tend to be more global in nature and in more defensive business models.

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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.

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