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International Growth Fund —
Fourth Quarter Manager Commentary
1st Quarter, 2019
"Our investment approach remains unchanged. We do not feel we have an edge in predicting market movements, and we therefore remain focused on the analysis of company fundamentals. "

Economic Overview
International stock markets were strong during the first quarter of 2019, with the MSCI ACWI ex U.S. Index gaining 10.3% during the quarter. Perhaps the most watched issue has been the build-up and subsequent delay of the U.K.’s departure from the European Union (Brexit), which was originally scheduled for the end of March. U.K. Prime Minister Theresa May has been unable thus far to garner sufficient support for her proposed deal from members of the U.K. parliament, and the saga continues. The U.K. stock market has performed relatively well throughout, with the FTSE 100 Index steadily rising since the start of the year.
Elsewhere, following the longest shutdown of the U.S. government on record, there has been renewed optimism of a trade deal between the U.S. and China, the Federal Reserve has kept interest rates unchanged at 2.5%, and a number of major economies have reported a decrease in economic growth, including China and Germany. Nevertheless, sentiment appeared to improve among investors during the quarter, and this shift in sentiment appears to have been the biggest change compared to the collective mood at the end of 2018.
Portfolio Review
In the first quarter of 2019, the Harbor International Growth Fund (Institutional Class) returned 13.34%, outperforming its benchmark, the MSCI All Country World Ex. US (ND) Index, which returned 10.31%.
After a challenging fourth quarter of 2018, the Fund rebounded somewhat during the first quarter of 2019. Fund holdings in Europe, emerging markets, and developed Asian markets were large contributors to relative performance. No regions detracted from relative results during the quarter. Stock selection drove relative outperformance during the quarter, with regional allocation detracting slightly from relative returns. At the sector level, the largest contributors to relative performance were Consumer Discretionary and Communication Services. Conversely, Consumer Staples and Energy detracted from relative performance during the quarter. Stock selection was also the dominant contributor to relative performance from a sector perspective, with sector allocation broadly neutral.
The growth version of the benchmark outperformed the value version during the quarter, which suggests to us that market conditions favored our growth style of investing. This differs from the previous quarter when the value version of the benchmark was the stronger performer. We stress that periods as short as one quarter are rarely reflective of long-term trends.
As the portfolio is constructed from the bottom up, we consider the performance of individual stocks to be the most relevant aspect of relative performance. During the quarter, the largest individual contributors to relative results included Canadian ecommerce platform provider Shopify, German online fashion retailer Zalando, and pharmaceutical equipment manufacturer Sartorius.
Following a difficult end to 2018, several of the Fund’s online-based holdings saw sharp recoveries in their share prices during 2019’s first quarter. Shopify and Zalando were the most significant of these holdings. Shopify aims to make it easy for merchants to sell online by offering them a variety of tools and services through a subscription-based sales model. The company’s 2018 results underlined the growth potential of the business, with revenue growth rates of 50% and higher. We think Shopify is becoming an increasingly attractive option for small enterprises and big businesses alike, and we believe the company’s approach of welcoming third parties to develop apps for its platform can help it to grow its lead over the competition. Zalando’s share price recovered from a gloomy finish to 2018, and the shares rose over 20% on the day the company released its results for 2018’s fourth quarter. The growth opportunity for online fashion sales in Europe remains vast, in our view, and we continue to believe Zalando is well placed to capture a meaningful share of that growth. In a similar vein, Sartorius saw its share price rise after releasing results to the market. While not growing quite at the pace of Shopify and Zalando, the company reported revenue growth of 13% for 2018, which was better than expected, and it indicated that it expects profit margins to expand modestly in 2019.
Two Indian businesses, Mahindra & Mahindra and United Spirits, detracted from relative performance during the quarter. United Spirits, a relatively recent addition to the Fund, is a leading Indian spirits business with an impressive portfolio of brands. The company delivered revenue and profit growth that fell short of analysts’ expectations during the quarter, but we are still encouraged by the growth of its premium brands and by the guiding presence of U.K. business Diageo, which is the company’s largest shareholder. Automotive and farm equipment manufacturing company Mahindra & Mahindra’s shares fell after the company delivered financial results that did not show any growth in earnings. We remain optimistic about the prospects within the company’s tractor division, but we share some of the market’s concerns in respect to the company’s auto division as competition is intense.
During the quarter, we purchased Sysmex for the Fund. Sysmex is a Japanese manufacturer of medical testing equipment. We believe the company could see continued revenue growth as demographic changes and improved standards of care drive rising spending on health care testing. Furthermore, we believe the company has a resilient business model and is well placed to take advantage of attractive opportunities in emerging areas of health care innovation. Recent weakness in the share price provided an attractive opportunity for us to take a holding in this long-term growth business.
Although we did not introduce any new themes during the quarter, the purchase of Sysmex does indicate our continuing interest in, and enthusiasm for, businesses we believe could benefit from improvements in health care diagnosis and testing. We believe that the Health Care sector may be set for drastic change, enabled on one side by technology and data processing and demanded on the other side by a need to cut costs and serve aging populations more effectively. We think that the next big winners are more likely to come from newer businesses than from existing "big pharma." While each investment decision we make is based on the attractions of each individual business, this thinking is behind our holding in Sartorius, the recent purchase of Sysmex, and the sale of Novo Nordisk.
We sold the Fund’s holding in Advantest, a Japanese manufacturer of test machines for semiconductors. We initially purchased the holding in Advantest based on the thesis that earnings were, in our view, likely to grow strongly, driven by an improved industry structure and rising demand for semiconductor equipment from existing and new testing areas and customers. At that time, the market appeared to take a far more pessimistic view of the future for Advantest. Since initiating the position, we have seen strong earnings growth and an improvement in the company’s profitability, and the market now values Advantest considerably higher. We no longer see Advantest as significantly differentiated and, therefore, decided to sell the position.
Relative to the benchmark, the largest country overweights entering 2019 were Sweden and India, whereas the most underweight country exposures were Canada and France. This is unchanged at the end of the quarter, with Sweden and India still the largest overweight exposures, and Canada and France the most underweight countries. The Fund’s portfolio is constructed from the bottom up, so these weightings simply represent where we have found what we believe are the best individual stocks in which to invest. We believe the overweight to Sweden says much more about corporate quality in Sweden than it does about the domestic economy. Most of our Sweden-listed exposure is in businesses with multinational interests. Our Indian weighting has grown over the past few years as we have become more optimistic of bureaucratic reform in a county with obvious demographic attractions. As the quality of local businesses has risen, we have been able to find a small number of investment opportunities for the Fund. Our underweight to Canada is a result of the commodity-heavy nature of the Canadian stock market, where we typically struggle to find sustainable enough competitive advantages. Our French underweight is also longstanding and probably reflects the growth prospects of the eurozone, which we believe are more muted than in other regions in international markets.
At the beginning of the year, Consumer Discretionary and Communication Services were the Fund’s largest overweight sectors relative to the benchmark, while Energy and Financials were the two most underweight. By the end of the quarter, Consumer Discretionary and Industrials were the most overweight, while Energy and Financials continued to be the largest underweights. During the quarter, the Consumer Discretionary overweight increased, primarily as a result of solid investment returns from the Fund’s Consumer Discretionary holdings, following a poor finish to 2018.
Our longstanding underweight exposures to Energy and Financials stocks reflect the difficulty of finding companies operating in those areas with what we view as truly sustainable competitive advantages. We tend not to invest on the basis of a particular energy price view, or with a strong macroeconomic view, which makes finding exploration and production companies and banks for investment very difficult. Where we do find opportunities, they tend to be businesses we believe can prosper in a wide range of price environments.
The change in collective mood among equity investors during the quarter appeared to have an impact on several of the Fund’s holdings, and, in aggregate, the Fund saw a rise in valuation as a result. While much of this rise can be attributed to stock specifics, we believe it is likely that the returning enthusiasm for higher growth, "riskier" assets was a helpful tailwind during the quarter. We remain focused, of course, on the long-term, fundamental attractions of the Fund’s holdings and have tried to look through short-term price swings.
We retain an optimistic outlook for the companies in the Fund. Each one has been selected on its own merits, and we believe their strong fundamentals may be rewarded in share-price terms in the long run. There remains much uncertainty about the prospects for international equities, but we are confident that our investment philosophy and process can continue to uncover growth businesses with strong chances of long-term success. Our investment approach remains unchanged. We do not feel we have an edge in predicting market movements, and we therefore remain focused on the analysis of company fundamentals.
We always keep a close eye on political and economic developments to the extent that they may impact the investment case for particular companies. In the case of Brexit, there is still a huge amount of uncertainty, with the deadline of the U.K.’s departure from the European Union now pushed back to October and no clarity on what an eventual Brexit will look like.
We do not believe the Fund contains any businesses that are unusually vulnerable to specific terms of the U.K.’s departure. We believe our holdings in domestically focused U.K. businesses are more likely than others to be affected if investors take a dim view of the U.K.’s prospects following its exit from the European Union, but our holdings are in businesses that are growing by taking share from incumbents, so we believe they could be insulated to a degree from downgrades to U.K. growth expectations.
We will amend our view with each concrete development in negotiations, but these have been surprisingly few and far between, and the latest extension suggests that we may have months more waiting ahead of us.

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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.