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Small Cap Core

as of 3/31/17

Fund Commentary

Small-cap stocks (Russell 2000® Index) lagged large-cap stocks (Russell 1000® Index), marking a reversal from the small-cap benchmark’s strong performance in 2016. In addition, a dramatic shift occurred among small caps, as investors rotated from value to growth. These changes reflected economic, political and monetary uncertainty, even as the rally pushed small-cap stocks to all-time highs.

The Small Cap Core Fund posted a total return of 1.74% for the quarter, compared with 2.47% for its benchmark, the Russell 2000® Index. The rotation into lower-quality stocks (as identified by our proprietary small-cap quality models) was evident in weaker stock selection in the healthcare sector, particularly among the formerly lagging biotechnology and pharmaceuticals industries, as well as among information technology and healthcare stocks. Although sector selection was positive, it was a modest contributor and did not overcome the stock selection headwinds.

The quarter was challenging, as our stocks rated “low quality” and excluded from further purchase significantly outperformed the better-rated stocks, particularly in the “growth” universe, where several technology-related industries (including biotechnology) had leading returns. The Fund’s underweight to outperforming stocks with no earnings and negative assets or cash flows meaningfully detracted from performance. The stocks with the deepest negative returns on equity — which our models tend to underweight — also were the best performers. (A similar pattern emerged for stocks with the most negative profit margins.) Micro-cap stocks (companies with capitalizations in the smallest three deciles) underperformed, in contrast to more risky stocks in larger capitalization ranges. Although stock selection was strong among micro-cap stocks, it was not sufficient to offset weaker stock selection elsewhere 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 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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