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Capital Appreciation Fund —
Fourth Quarter Manager Commentary
2nd Quarter, 2019
"While the Harbor Capital Appreciation Fund's holdings are not immune from the impact of tariffs, we believe that few face material risk of being competitively disadvantaged by the evolving trade landscape. "

Market in Review
U.S. equities extended their 2019 gains into the second quarter, but with substantial volatility. Trade tensions – reignited by the threat of tariffs on essentially all U.S. imports from China, the U.S. government’s designation of Chinese telecommunications giant Huawei as a national security risk, and potential tariffs on Mexican goods (as a means to press action to halt Central American migrants from crossing into Mexico on their way to the U.S.) – created uncertainty and concern. Equity markets abruptly changed course on short-term developments, selling off on heightened discord, rallying on reduced tension. U.S. housing and auto sales remained weak. Strong employment supported continued slight wage gains and consistent levels of consumer demand. However, trade friction weighed on consumer and business sentiment, and led to reduced Gross Domestic Product ("GDP") growth estimates. Against this backdrop, U.S. government bond prices rallied, with yields on long-term Treasuries ending the quarter at a pronounced discount to the federal funds rate. The Federal Reserve signaled a willingness to ease interest rates. China used policy stimulus to blunt the impact of slowing exports, supporting stable, approximately 6% GDP growth. Renewed political tensions with Hong Kong added another complication to China’s economic concerns. Growth in Europe remained soft. After three years of debate ended in failure to deliver an exit deal with the European Union, U.K. Prime Minister Theresa May resigned. The U.K. economy slipped further toward recession amid the rancor and uncertainty, teetering on the brink of no growth as the quarter ended.
Portfolio Performance
In the second quarter of 2019, the Harbor Capital Appreciation Fund (Institutional Class) returned 3.03%, underperforming its benchmark, the Russell 1000® Growth Index, which returned 4.64%.
Among the benchmark’s major sectors, Information Technology and Consumer Discretionary outperformed the overall index, while Health Care and Communication Services underperformed. Smaller sectors Financials and Materials posted the biggest gains. Energy was the lone sector to lose ground.
The Fund underperformed the index. Every sector in the Fund gained ground – Financials, Consumer Staples, and Information Technology the most; Communication Services and Consumer Discretionary the least. Consumer Staples holdings were strong contributors to absolute and relative performance. Stock selection was beneficial in Health Care. Information Technology, Consumer Discretionary, and Communication Services positions advanced but lagged the benchmark’s corresponding sectors.
Contributors and Detractors
In Information Technology, payments companies benefited from the shift from cash to electronic transactions. MasterCard and Visa have strong market positions with high barriers to entry, pricing power, and operating leverage. PayPal offers low-cost, high-security digital payment options. FleetCor provides charge cards and payment-processing services for trucking fleets. Digital transformation of the enterprise has become a strategic imperative across many industries. Microsoft, Adobe, Workday, and ServiceNow offer mission-critical applications that are changing business operations.
Other contributors spanned the Consumer Staples, Consumer Discretionary, and Communication Services sectors. In Consumer Staples, Costco’s membership income allows for low prices and broad product selection, leading to high inventory turnover. Estée Lauder has enhanced its brand portfolio with complementary acquisitions and brand development. Emerging markets are key drivers of the company’s growth. In Consumer Discretionary, Amazon continues to benefit from economies of scale and its platform-based business model. Lululemon’s products, brand positioning, marketing, and online sales are driving strong customer traffic and comparable store sales. In Communication Services, Facebook is showing resilience despite worries about data privacy, with solid engagement metrics and revenue growth, as advertisers seek the reach and targeting Facebook provides.
Among detractors, Alphabet’s decline reflected slowing revenue growth and regulatory scrutiny. Nvidia fell on worries that trade discord could depress chip demand. Slowing Chinese economic growth and government efforts to tighten control of Internet and financial businesses weighed on Alibaba. Tesla’s decline reflected controversy surrounding its CEO and concerns about production and demand.
Buys and Sells
A position in Uber was initiated during the quarter. The ride-sharing industry has become a transformational growth sector of the global consumer market over the past five years, and Uber has established itself as the leader. The “transportation as a service” model has clear benefits, in our opinion, for consumers, who are increasingly shifting from taking taxis or their own vehicles to the convenience and cost savings of on-demand ride-sharing. Uber customer loyalty is strong, and the company has attracted new drivers and consumers at a strong pace. We believe Uber’s ride-sharing platform has the potential to develop into a broader consumer engine, with Uber Eats, Uber Freight, and autonomous initiatives representing only preliminary steps toward realization of longer term monetization opportunities. The company’s global platform has expanded to more than 700 cities, yet its penetration remains minuscule in the context of the total addressable market.
The position in Red Hat was eliminated during the quarter. The U.S. Department of Justice approved IBM’s acquisition of Red Hat, the market-leading vendor of Linux, an open-source computer operating system, in May.
After months of trade friction, consumer and business sentiment show signs of starting to fray. Prolonged uncertainty is forcing revisions to corporate profits growth forecasts, alterations to business plans and supply chains, and scaled-back estimates of global Gross Domestic Product (GDP) growth. With substantial gains in equities markets already this year, the heavy pull of macro and political concerns could cause investors to take pause. If the most onerous proposed tariffs are implemented and discord devolves into a full-on trade war, sentiment could deteriorate meaningfully. The possibility of disappointing second quarter earnings and reduced expectations, coupled with valuations that have moved higher, suggests a rising risk of a market pullback. There are solid positives to counter this cautious perspective. Labor market strength persists, inflation remains benign, and the Fed’s next move is likely to be an easing of interest rates. While the Fund’s holdings are not immune from the impact of tariffs, we believe that few face material risk of being competitively disadvantaged by the evolving trade landscape. They are, by and large, market leaders in their industries, operating in secularly growing markets and generating the necessary cash flow to reinvest for attractive rates of organic revenue and above-market-average profits growth.

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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.