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Small Cap Growth Fund —
Fourth Quarter Manager Commentary
2nd Quarter, 2019
"Despite concerns over slowing growth, we believe there is cause for optimism. The U.S. consumer remains very healthy, with continued strength in the labor market, rising wages, and low debt. "

Market in Review
U.S. equities were volatile during the second quarter of 2019 as investors digested trade headlines and Federal Reserve (Fed) policy developments. Ultimately, stocks finished higher at the end of the quarter to culminate the best first-half performance since 1997. Gains in April, which were supported by continued optimism of a trade resolution, were quickly eliminated as communication broke down between the U.S. and China and additional tariffs were announced. In conjunction, deteriorating industrial data points led to the resumption of recession calls despite the continued solid footing of our consumer-driven economy. In early June, comments from the Fed alluding to its willingness to proactively aid market expansion amid softening conditions bolstered the market into a rally through the end of the quarter. During the period, investors demonstrated a preference for traditional, late-cycle leadership with a bias toward quality, growth factors, and size.
Portfolio Performance
In the second quarter of 2019, the Harbor Small Cap Growth Fund (Institutional Class) returned 5.11%, outperforming its benchmark, the Russell 2000® Growth Index, which returned 2.75%.
Outperformance was broad-based, with eight sectors adding to relative returns. Fund investments within Information Technology, Health Care, and Consumer Discretionary were particularly strong, offsetting weakness within Industrials.
Contributors and Detractors
Tableau, which provides analytics and data visualization software, was the portfolio’s top relative performer during the quarter. Tableau was acquired at a premium by Salesforce during the period, causing the stock to climb meaningfully.
Aerospace & Defense companies Heico and Teledyne Technologies – both top ten Fund holdings –added relative value during the quarter, as aging airline fleets require more maintenance and/or parts replacements.
Intersect ENT, a fast-growing surgical products company dedicated to the treatment of ear, nose, and throat (ENT) conditions through evidence-based innovation, traded lower during the quarter following the news that the CEO would be stepping down. While this news pressured the stock during the quarter, we view it as a positive for the company from a value-driving perspective. Although there is no obvious replacement in the near-term, we continue to like the company and believe it could be a good strategic fit for a number of major medical technology companies going forward.
Rush Enterprises, which operates a regional network of commercial truck dealerships offering both sales and services, declined after reporting lower-than-anticipated new truck sales despite beating consensus earnings estimates. While we believe Rush’s services business is more important to the long-term health of the company than new truck sales, investor concerns that the weaker new sales number was a symptom of the slowing economy weighed on the stock. In our view, Rush's services business, a meaningful source of growth due to its higher margins and steady recurring revenue, continues to drive long-term growth.
Buys and Sells
Timken, a seller of engineered bearings and mechanical power transmission products, was added to the Harbor Small Cap Growth Fund (“Fund”) during the quarter and contributed positively to relative returns. Since spinning off its capital intensive, hyper-cyclical steel manufacturing business in 2014, Timken has improved operations, margins, and free cash flow, making it an attractive candidate for the portfolio. Timken has also diversified away from its lower-margin auto business and into more niche, higher-margin areas through mergers and acquisitions. We believe the current valuation fully discounts a recession case and the company's high free cash flow conversion should allow continued growth in dividends paid and stock repurchases, reducing volatility and downside for this small cap cyclical company.
Inphi, a chipmaker supplying one of the highest growth areas in communication technology, was sold from the Fund during the quarter. Despite a strong track record of new product launches and attractive gross margins, the stock was trading close to our price target. Additionally, given the company’s sizable China exposure (which would be directly impacted by trade war escalations), we decided to sell and redeploy the proceeds into investments with more favorable risk-reward trade-offs.
A differentiating characteristic of Westfield is that we invest in both secular and cyclical growth companies, which we believe deliver more consistent results over time. We continue to find excellent opportunities in high quality compounders with earnings growth visibility – for example, aerospace and defense, payment processors, and medical technology. While we view some segments within software as priced fairly, we continue to see relative value in this industry group, as well as businesses with disruptive technology, large addressable markets, and strong cash flows. We are also being selective within Industrials, Materials, and Energy, as many of these companies are trading at trough multiples, discounting a recessionary scenario.
Despite concerns over slowing growth, we believe there is cause for optimism. The U.S. consumer remains very healthy, with continued strength in the labor market, rising wages, and low debt. Although we are in the midst of an industrial soft patch, we believe that an accommodative Federal Reserve, an ultimate resolution to trade conflict with China, and the lagged impact of stimulus in China should drive a resumption in global growth. However, we do expect a period of elevated volatility in the market over the coming quarters as trade headlines and other geopolitical and macro developments create periods of uncertainty and fear. Ultimately, this can create attractive opportunities for fundamental stock pickers, and in our view, Westfield’s long history of deep fundamental research should prove beneficial in this environment.

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

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.