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Small Cap Core

as of 9/30/16

Fund Commentary

Small-cap stocks (Russell 2000® Index) outperformed large-cap stocks (Russell 1000® Index) in a quarter that rewarded the riskiest and lowest-quality stocks, despite several global economic and political uncertainties. Continued accommodation from central banks, along with continued, albeit slow, domestic growth, overshadowed concerns about Brexit, slowing margins, productivity, and uncertain global growth.

The Small Cap Core Fund returned 7.87%, compared with 9.05% for the Fund’s benchmark, the Russell 2000 Index. As intended, stock selection, rather than sector allocation, was the main driver of the Fund’s underperformance, particularly within the information technology, healthcare, and financials sectors. In each of those sectors, low-quality stocks, as defined by our proprietary exclusion model, outperformed higher-quality stocks. This dynamic was most pronounced in the healthcare sector, where low-quality stocks outperformed by more than 20%, largely due to the outperformance of the biotechnology industry.

In general, stocks with no earnings, negative return on equity (ROE), and negative profit margins, outperformed. These trends also contributed to the success of stocks with deep valuations (low price-to-book or price-to-earnings ratios) and high volatility, reversing a pattern of the prior year in which these stocks underperformed. This sharp reversal occurred in every sector except real estate and utilities (both lagging sectors this quarter) and in contrast to long-term relative performance patterns.

Micro-cap stocks outperformed, and the Fund’s modest overweight to this market segment aided performance, but not enough to overcome the underperformance of the Fund’s higher quality, larger-cap stocks, which had larger weightings in the Fund.

Going forward, we will continue to invest in a diverse portfolio of small-cap stocks in a cost-efficient manner. We will continue to seek exposure to micro-cap stocks while seeking to avoid stocks with lower-quality characteristics, as indicated by our proprietary quality model.

Not FDIC insured | May lose value | No bank guarantee

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Please carefully read the prospectus and summary prospectus and consider the investment objectives, risks, charges and expenses of Northern Funds before investing. Call 800-595-9111 to obtain a prospectus and summary prospectus, which contains this and other information about the funds.

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