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Convertible Securities Fund —
Fourth Quarter Manager Commentary
2nd Quarter, 2019
"Similar to the first quarter, the continued strength in new-issue activity provided opportunity to further diversify the Harbor Convertible Securities Fund. "

Market in Review
Performance during the first half of 2019 surprised and delighted most investors. Last December, the general consensus was for higher interest rates, rising inflation, and an impending recession, which rattled the markets. However, most forecasts have been upended as the markets staged a dramatic rebound, with the three major U.S. equity indices hitting record highs and the 10-year U.S. Treasury yield hovering around 2%. Meanwhile, the markets have had to contend with an inverted yield curve, an unresolved trade dispute with China, low inflation, slower earnings momentum, a robust job market, and a more dovish U.S. Federal Reserve policy. Amid the longest period of economic growth since 1854, the greatest danger to the markets, in our view, may be the unpredictability of economic and market forecasts in an era of dislocations due to technology, demographic shifts, and social change.
Portfolio Performance
In the second quarter of 2019, the Harbor Convertible Securities Fund (Institutional Class) returned 3.28%, underperforming its benchmark, the ICE BofAML US Convertible Excluding Mandatory Index, which returned 3.92%.
During an otherwise mixed second quarter, with June’s gains retracing May’s losses, the Fund trailed the benchmark. The disparity with the benchmark can be more than accounted for by the Fund’s underweighting in the most equity-like benchmark constituents (those with a 100% investment premium or more), which contributed 143 basis points (36.5%) of the benchmark’s second-quarter return. As a matter of style, we tend to underweight or avoid convertible securities of this type, as they have little to no bond characteristics and are closely correlated to equity risk/volatility. It should also be noted that the greater portion of the Fund’s performance can be primarily attributed to security selection in the more credit sensitive securities with an investment premium of less than 40%, which stylistically is a primary area of focus.
Portfolio Positioning
The Fund’s largest industry exposures as of June 30 were software, semiconductors and semiconductor equipment, health care equipment and supplies, Internet and direct marketing retail, and media. At the end of the quarter, the Fund had an average credit quality of BB, equal to that of the benchmark index. The Fund’s effective duration was shorter than the benchmark’s, 2.07 versus 2.78, respectively. The average weighted investment premium of the Fund was calculated at 26.77% on June 30, 2019, versus 28.32% on March 31, 2019. During the same time, the average weighted underlying equity premium expanded from 38.81% to 41.01%.
Contributors and Detractors
The five largest contributors to the Fund’s absolute performance during the quarter were Exact Sciences, DISH Network, Dexcom, Meritor, and Insulet. Exact Sciences, a life science equipment company, has developed a non-invasive screening test for the early detection of colorectal cancer. DISH Network, a provider of satellite-based pay-TV services, has recently benefited from speculation about its potential purchase of Sprint/T-Mobile-divested assets. Dexcom, a medical device company focused on the development of continuous glucose monitoring systems for diabetes, has continued to benefit from sustained revenue growth in an underpenetrated market. Meritor, a manufacturer of components used in trucks and trailers, has benefited from an extended heavy-truck backlog amid improving margins, while Insulet, a medical device company that manufactures an insulin-infusion system, recently raised earnings guidance based on strong patient growth.
The five largest detractors from absolute performance were Tesla, Chesapeake Energy, Intel, Pure Storage, and Palo Alto Networks. Tesla has been the subject of speculation surrounding its ability to maintain production schedules. Chesapeake Energy has seen concerns surrounding its ability to reduce its leverage profile amid recent commodity price volatility. We will continue to monitor closely. Intel has seen a semiconductor inventory buildup amid trade war uncertainty and a competitive landscape. Pure Storage, a provider of enterprise storage solutions, posted disappointing first-quarter earnings; however, we believe the company’s fundamentals are still intact. Palo Alto Networks, a leading provider of network security systems, recently missed earnings-per-share consensus estimates, citing the integration of recent acquisitions.
Buys and Sells
During the quarter, we purchased shares of Altair Engineering, a global technology company providing software and cloud solutions in the areas of product design and development, high performance cloud computing, and data intelligence. Altair serves more than 5,000 customers in the automotive, aerospace, heavy equipment, and consumer product industries, among others. We believe Altair’s 0.25% convertible notes are attractive for the several reasons. The company’s addressable market is growing at a healthy rate (high single digits), and we expect Altair to outpace market growth as it gains share in the solver segment. The core mesh product’s open architecture has been a key differentiator in the market, and its ability to integrate with other software systems has helped establish strong relationships with customers. A unique pricing strategy has provided efficient upsell opportunities and expansion; the average customer uses 15 products. Finally, the credit is supported by strong free cash flow generation and a meaningful equity cushion.
Similar to the first quarter, the continued strength in new-issue activity provided opportunity to further diversify the Fund through other selective purchases, including Guess, a licensor of casual apparel and related consumer products; Liberty Latin America, a provider of a variety of telecommunication and entertainment services in the Caribbean and Latin America; Vonage, a provider of high-speed Internet communication services; and Zynga, a leading social gaming company. In addition, for the purpose of rebalancing in a strong equity environment, we added new issues from currently or previously held deeper-in-the-money tranches from IAC/ Interactive, a provider of Internet search applications, among them and Home Advisor; Interdigital, a designer and developer of advanced digital wireless applications; and the aforementioned Dexcom.
On the sell side, we exited our position in HubSpot, a cloud-based marketing and sales software platform, after many reductions in weight over the last year, due to high equity sensitivity and valuation. We redeployed the proceeds into other names in software with a more balanced profile.
Looking forward, similar to 2018, we believe the following prospects for convertible securities appear positive and could remain so for the indefinite future, lacking any material macro developments: a growth-oriented equity environment, positive overall credit conditions, historical non-correlation to U.S. Treasury rates, and increased new-issue activity. As we have experienced a period of interest rate and economic uncertainty, with associated intermittent periods of volatility, we believe the market is likely to favor more balanced convertible securities with a positive credit profile, placing a premium on reward versus risk.

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.