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Mid Cap Growth Fund —
Fourth Quarter Manager Commentary
2nd Quarter, 2019
"With secular growth tailwinds persisting through the quarter, we are still finding a significant number of opportunities benefiting from economic expansion. "

Market in Review
U.S. equities ended the second quarter of 2019 higher. Unresolved U.S. trade frictions with China, Mexico, Japan, and the European Union unsettled markets and raised concerns about the potential risks to U.S. economic growth from increasing cost pressures, supply chain disruptions, and waning business confidence and investment plans. Tensions between the U.S. and China were particularly volatile, with negotiations abruptly breaking down in May prior to the two countries agreeing to halt incremental tariffs and resume trade negotiations when they met at the G20 conference in June. In its June policy statement, the U.S. Federal Reserve highlighted its expectations for sustained economic growth, a strong labor market, and muted inflation pressures, but it noted that increasing uncertainties to its outlook have strengthened the case for additional policy accommodation. Market sentiment was bolstered by better than expected first-quarter earnings despite concerns about peak margins and slowing growth. The blended year-over-year earnings decline for the S&P 500 Index was -0.8%, down from 13.1% growth in the fourth quarter of 2018. Some of the largest U.S. technology firms fell sharply after U.S. regulators and lawmakers prepared to investigate potential antitrust issues.
Portfolio Performance
In the second quarter of 2019, the Harbor Mid Cap Growth Fund (Institutional Class) returned 6.14%, outperforming its benchmark, the Russell Midcap® Growth Index, which returned 5.40%.
Relative outperformance for the period was driven primarily by favorable security selection, particularly within Health Care, while Industrials also contributed. In contrast, security selection was weak within Information Technology and Consumer Discretionary. Sector allocation, a result of our fundamental stock selection process, detracted from relative results. The Harbor Mid Cap Growth Fund’s ("Fund") underweight to Financials and overweight to Health Care detracted most. As is typical with the Fund, sector positioning is a fallout of our fundamental investment process but can be an indication of where we are finding our most compelling investment ideas.
U.S. mid-cap equities advanced during the second quarter, while mid-cap growth equities performed strongest. High growth stocks outperformed their lower growth counterparts, an environment that is typically favorable for our style of investing. Macro events can affect short-term performance, but typically we believe security selection will drive relative performance over the long-term. In terms of risk factors, our style factors were a modest tailwind for the second quarter and have been a tailwind year-to-date, as growth stocks continued their rebound from their sell-off at the end of 2018.
Contributors and Detractors
Exact Sciences, a molecular diagnostics company and provider of Cologuard, was the most notable individual contributor to relative performance. Exact announced solid first-quarter results in April, with both revenues and Cologuard test volumes handily beating consensus expectations. The company lifted the initial second-quarter and fiscal year 2019 revenue guidance, and the stock rallied as a result. Haemonetics, a provider of hematology (blood) products and solutions, was the second-largest contributor to relative results. The company reported first-quarter earnings in May that exceeded consensus expectations, with notable margin expansion. The company also displayed strong results in its plasma business, which is a key growth driver and tenet of our thesis. Additionally, management also announced a $500 million share buyback plan (10% of shares outstanding) to be completed over the next two years.
In terms of detractors from relative performance, application and data infrastructure software provider Pivotal Software, Inc. was most notable. The company reported a mixed quarter but slashed revenue guidance significantly, due to “market complexity” causing a shift in demand. Competitive pressures from other Platform-as-a-Service providers and hybrid cloud offerings were a headwind on bookings. The stock sold off sharply as a result, and our overweight position weighed on relative performance. 2U, a provider of cloud-based software solutions enabling online education programs, was another detractor. The company provided a modest upside to consensus expectations in its first-quarter results but presented a disappointing outlook driven by a slowdown in its core graduate degree segment. This sent shares down over 15%. Management highlighted lower admission rates by university partners as the main culprit for this slowdown.
Buys and Sells
We added to online home furnishings provider Wayfair after the stock pulled back during the quarter. This stock has been a long-term portfolio holding, and we had trimmed our position during the first quarter after a sharp rally in the stock price. We continue to think Wayfair remains a leader in the online furniture market and could continue to gain market share of this very large, addressable market. We participated in Pinterest’s initial public offering that occurred in April. Pinterest is a social media web and mobile application company. Shares jumped 26% after the first day of trading. We continue to see a compelling opportunity for user growth internationally and believe the company can continue to improve its ad load and pricing. Pinterest’s advertising can be highly topical and, therefore, not nearly as intrusive as other platforms, which we believe could lead to higher engagement rates and better ad pricing.
Notable sales within the portfolio were Chipotle Mexican Grill and Shopify, two names we continue to like but believe valuations have become extended. The recent success of Chipotle’s online delivery boosting sales for the company appears to be more appreciated by the street than when we initiated our position in January. Our level of differentiation relative to consensus estimates has waned, and the valuation no longer appears as attractive to us after the recent run in the stock price. We continue to favor Shopify’s business model and fundamentals, but the stock had quickly exceeded our price target after a strong run year-to-date.
During the second quarter, we increased exposures to Information Technology and Health Care, and we decreased exposures to Industrials and Financials.
Outlook
Our market outlook at the end of the second quarter is consistent with our thinking at the start of the period. We continue to believe the recent volatility in the stock market is for the most part driven by market sentiment around geopolitical concerns, and, broadly speaking, we believe fundamentals remain strong. We are leaning into positions where we believe the street is being overly fearful of a bear case scenario and selling names where we think the market is complacent or overly optimistic. With secular growth tailwinds persisting through the quarter, we are still finding a significant number of opportunities benefiting from economic expansion. However, we are being more tactical in deploying proceeds from recent stock sales in names where we believe valuations have become extended. Ironically, increased trade tensions over the past six months may lead to reductions in interest rates, which we believe could benefit growth stocks given the lower implied discount rates going forward.

Performance data shown represents past performance, which is no guarantee of future results. Current performance may be higher or lower than the past performance data shown. Investment returns and the value of an investment will fluctuate, and an investor's shares, when sold, may be worth more or less than their original cost. You can obtain performance data current to the most recent month-end (available within seven business days after the most recent month-end) by calling 800-422-1050 or visiting harborfunds.com.

Performance figures discussed reflect that of the institutional class shares.

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.