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International Small Cap Fund —
U.S. Dollar strength constrained international equity market performance
3rd Quarter, 2018
"We believe the international smaller companies asset class is one that offers many opportunities for bottom-up stock pickers over the longer term. "
– Baring International Investment Limited (Barings)

During the third quarter of 2018, global equity markets benefited from the boost provided by a strong U.S. economy, although returns from international equity markets were constrained, in U.S. Dollar terms, by the U.S. Dollar’s relative strength. Furthermore, while on a global basis changes in analysts’ forecasts of corporate profit growth were slightly positive during the quarter, the upward revisions reflect increased profit forecasts for U.S. companies and slight downgrades to expectations of corporate profit growth in the rest of the world. In this context, international smaller companies fell slightly overall during the quarter, in U.S. Dollar terms. International companies with a high volume of sales in emerging economies were particularly weak performers, as they were negatively affected by political and economic developments in Russia, Argentina and Turkey, and by the U.S.-China trade disputes.
Against this backdrop, the Harbor International Small Cap Fund returned 0.58%, outperforming the Fund’s benchmark, the MSCI EAFE Small Cap (ND) Index, which returned -0.88%. From a sector perspective, Consumer Discretionary contributed to relative performance, due to stock selection. Conversely, stock selection in Information Technology detracted from relative results. Among countries, the U.K. contributed to relative performance, due to stock selection. In contrast, security selection in France hindered relative performance.
Barings’ 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

Our Focus Remains on Stock Selection
Central banks across developed markets continue to pursue accommodative monetary policies, and we believe equity markets remain reasonably attractively valued relative to other asset classes. Accordingly, our focus remains on stock selection and on identifying unrecognized growth opportunities among the diverse and wide investment universe available in international smaller companies. With a backdrop of continued, but slow, economic growth, one of our key concerns remains the developments around corporate profit margins. The management of salary costs represents a continued challenge, in our view, while low inflation highlights the risk to companies from higher input costs, although commodity price inflation has slowed in recent months.
Opportunities for Bottom-Up Stock Pickers Over the Longer Term
We believe the international smaller companies asset class is one that offers many opportunities for bottom-up stock pickers over the longer term. The asset class has not yet attracted greater sell side analyst coverage, so we believe considerable opportunities remain to add value through bottom-up research in what is a large, diverse and growing section of the market.
Shorter Term Outlook More Challenging to Forecast
We believe the shorter term outlook, though challenging to forecast, has probably improved slightly since the beginning of the third quarter. Although political and macro-level developments retain the capacity to upset global equity markets, recent policy actions generally appear to have calmed nerves. In this context, while the leaders of the governments of Germany, France, Japan, the U.K. and Australia are each experiencing weakening popular support, we believe there is little likelihood of a leadership change what would result in policy change sufficient to significantly disconcert equity markets.
Smaller Companies Remain Attractively Valued
We continue to see economic expansion in 2018, albeit more modest than in 2017. Further volatility due to geopolitical tensions in a number of regions remains a significant possibility, in our view. Nevertheless, we believe international smaller companies remain attractively valued, relative to other asset classes and relative to their historical valuation ranges, should earnings growth somewhere close to recent forecasts be achieved. A continuing area of focus, particularly for the companies represented in the portfolio, will be the resilience of their profit margins given the input cost pressure challenges posed by higher raw materials prices and the likelihood of rising labor costs. This assessment is consistent with our view at the start of 2018. Our focus will continue to be on identifying individual companies, assessing the outlook for their products and margins, the sustainability of their competitive advantages, the strength of their balance sheets and the skills of their management teams in deploying capital to create value for shareholders.

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.