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Global Leaders Fund —
Fourth Quarter Manager Commentary
1st Quarter, 2019
"The first quarter was supportive for global equities, and the Fund was a beneficiary. "

Economic Overview
Global equities rose in the first quarter of 2019 (as measured by the MSCI All Country World (ND) Index, which gained 12.18%), erasing December’s losses. The strength was broad based, with every sector and major country posting gains year-to-date. The quarter’s gains were led by the U.S., which posted its best quarterly return since 2009, and accounted for over 60% of the MSCI index’s results. While last year’s concerns about a global growth slowdown persist, stocks broadly rerated on resilient U.S. economic data, better-than-expected corporate earnings, and easing U.S.-China trade tensions. Late in the quarter, a dovish pivot by the U.S. Federal Reserve provided an additional boost to U.S. markets. China was another bright spot, as trade deal optimism, announced government stimulus, oversold conditions, and news that MSCI planned to include more mainland Chinese shares in its benchmark indices all contributed to equity market gains. From a sector perspective, Information Technology produced the greatest absolute return and contributed most to the index’s rise. Real Estate and Energy – supported by a 25% surge in oil prices – were other notable performers.
Portfolio Review
In the first quarter of 2019, the Harbor Global Leaders Fund (Institutional Class) returned 16.07%, outperforming its benchmark, the MSCI All Country World (ND) Index, which returned 12.18%.
The first quarter was supportive for global equities, and the Fund was a beneficiary. The Consumer Discretionary and Information Technology sectors – which each represent overweights of more than 10 percent for the Fund relative to the benchmark – saw double-digit rises during the period. However, security selection – stemming from fundamental, business-focused research – contributed most to the Fund’s relative return for the quarter.
The U.S./Canada and developed-market Asia were the top regional contributors to relative investment results. Latin America was the sole regional detractor. From a sector perspective, Industrials and Information Technology were the top relative contributors, and Energy – a zero percent weighting – was the lone sector detractor. The Fund’s sector weightings are purely a residual outcome of the bottom-up stock selection process.
The top relative contributors were TransDigm, Alibaba, Intuit, Visa, and Alimentation Couche-Tard.
TransDigm continues to deliver strong results. The company – which manufactures aerospace components – has strong pricing power, as approximately 80% of sales are generated from products in which TransDigm is the sole source supplier. Over our investment horizon, we believe TransDigm will generate annualized pricing growth of 3% to 4% in its commercial aftermarket and defense businesses, the former of which should grow roughly in-line with fleet on a volume basis. Another component of our case is accretive merger and acquisition (M&A) activity, as highlighted by the company’s recent acquisition of Esterline Technologies. Esterline, an aerospace supplier across the commercial, defense, and industrial/medical segments, is TransDigm’s largest acquisition to date based on enterprise value. We believe many of the company’s products align nicely with TransDigm’s existing commercial aftermarket and defense portfolios. We expect low double-digit annualized earnings growth over the Fund’s investment horizon, with additional upside from M&A activity. In the absence of the latter, we believe TransDigm would still compensate shareholders via special dividends, which it has a history of executing.
The top relative detractors were EssilorLuxottica, Texas Instruments, United Health, Intercontinental Exchange, and Booking.
Shares of EssilorLuxottica (Essilux) came under pressure as the former CEOs of Essilor and Luxottica have engaged in a public battle over the merger agreement and group structure of the combined entity. We long acknowledged that the biggest risk to the business was the integration and combination of the two management teams and cultures, and we believe it will likely take longer for Essilux to realize synergies from the combination of the two predecessor companies. While the public spat escalated toward the end of the quarter, we are hopeful that the path forward will be smoother. Both CEOs continue to reiterate the strategic rationale for the merger and seem to admire the quality of the other’s management teams. Despite the short-term noise, we continue to favorably view the business’s long-term prospects. It is a near-monopoly in ophthalmic lenses and frames, and looking ahead, we see a number of growth drivers that could result in a quadrupling of the addressable market. These drivers include the underpenetrated but large and growing online business, a turnaround in China, continued U.S. growth as more doctors and retailers join the network, and new value-added products. Essilux should sustain above-average growth for decades, in our view, and we are optimistic that the new management team will be committed to realizing synergies sooner rather than later.
Boston Scientific (BSX) was added to the Fund’s portfolio during the first quarter. The company is one of the largest and fastest-growing globally diversified medical-device companies. Since bringing in new management in 2012, BSX has transformed from a slow-growing, legacy-product business into an innovator with strengthening leadership positions across several large categories of devices. As part of this transition, BSX refocused on minimally invasive procedures, and has prioritized investment via internal innovation and strategic tuck-in acquisitions. We believe BSX’s strong pipeline of innovative products across all its major business lines—including Cardiovascular, Rhythm Management, and MedSurg—will accelerate growth over our investment horizon. BSX’s scale and distribution capabilities are an additional advantage. We view these capabilities as especially important for medical devices, given the role that the sales force plays in educating practitioners on new devices and techniques. Finally, we believe that management has a strong track record of smart capital allocation, and expect additional upside from prudent, value-added M&A. Over the next five years, we expect meaningful free cash flow generation and margin expansion through positive product mix shifts and operating leverage.
We sold Fomento Económico Mexicano (FEMSA) in the first quarter. In aggregate, FEMSA continues to meet our investment criteria, and we maintain high conviction in the prospects for its Oxxo business, a leading Latin American convenience store chain. However, we expect FEMSA’s overall growth to slow due to its jointly owned bottling franchise, Coca-Cola FEMSA. While the bottling business remains highly cash generative, it is susceptible to cyclical factors, including macro and currency volatility. Given the Fund’s mandate, we decided to invest the proceeds into Texas Instruments, which we expect to have a more stable growth trajectory.
Given the long-term and business-focused nature of our investment approach, we typically avoid making calls on the direction of the market. Rather, we remain focused on the fundamental strengths and long-term growth prospects of our portfolio businesses, which are typically independent of macro events and/or conditions. We are optimistic about the growth prospects for our businesses. We believe they are well positioned to deliver strong business results and earnings growth over our five-year investment horizon.

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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.