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Small Cap Core

as of 12/31/16

Fund Commentary

A rally following the U.S. presidential election propelled smaller, riskier and more-cyclical stocks, and small-cap stocks (Russell 2000® Index) once again outperformed large-cap stocks (Russell 1000® Index). Small-cap value stocks were particularly strong, ending the year up almost 32% (Russell 2000® Value Index), while small-cap growth stocks (formerly dominant in returns) lagged but still managed double-digit returns for the year.

The Small Cap Core Fund posted a total return of 8.98% for the quarter, compared with 8.83% for its benchmark, the Russell 2000® Index. Stock selection within the healthcare sector, particularly among the lagging biotechnology and pharmaceuticals industries (as well as an underweight to biotechnology), made the most significant contribution, despite a sharp but short-lived biotechnology rally after the election. The Fund’s information technology and energy sector holdings were less competitive. Sector positioning was a modest detractor, mostly due to an underweight in the rallying financials sector, where banks returned almost 30% for the quarter.

Micro-cap stocks (companies with less than $250 million capitalization) outperformed, as a less-risk-averse market rewarded more speculative investments. But more significant for Fund performance, the larger-cap companies in the Index (capitalizations greater than $2 billion) lagged the broader small-cap market. Much of the underperformance came from formerly strong performers, reflecting the sharp divergence in performance between stocks with high momentum (the best-performing stocks over the previous year) and the deepest value (lowest price-to-book ratio). Meanwhile, stocks of less-profitable companies (companies with lower returns on equity and profit margins) underperformed, suggesting deep valuation (cheapness) alone was not enough to attract investors.

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 avoiding 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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