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Convertible Securities Fund —
Fourth Quarter Manager Commentary
1st Quarter, 2019
"Looking forward, similar to the start of 2019, we believe that the overall prospects for convertible securities remain positive. "

Economic Overview
Financial markets were dealt a much-needed reprieve in the first quarter of 2019 following a treacherous end to 2018. The S&P 500 Index posted its best quarterly return in a decade, a gain of 13.65%. At the same time, the high yield market generated the best quarterly performance since 2009. The remarkable recovery was largely the result of the Federal Reserve’s (the Fed’s) game-changing shift in monetary policy. This market optimism occurred despite faltering global growth, the unresolved trade battle with China, and the threat of a U.S. recession in 2020. Fears were exacerbated by the surfacing of an inverted yield curve for the first time since 2007. Despite weakening momentum in the U.S. economy and a slowdown in corporate profits, demand for equities and bonds surged. Who could have forecast that 10-year U.S. Treasury yields would fall from 3.24% in November 2018 to 2.37% in March 2019? The game-changer appears to be the Fed’s statement that it does not intend to hike rates this year.
Portfolio Review
In the first quarter of 2019, the Harbor Convertible Securities Fund (Institutional Class) returned 9.32%, underperforming its benchmark, the ICE BofAML US Convertible Ex Mandatory Index, which returned 10.08%.
During the quarter, the five largest contributors to absolute performance were Wayfair, Exact Sciences, Live Nation, and Ctrip.Com International (CTRP). Though diversified in their customer end user base, each of these companies is similar in that they have continued to show strong revenue growth. Wayfair is an e-commerce distributor of household goods. Exact Sciences, a life science equipment company, has developed a non-invasive screening test for the early detection of colorectal cancer. The company expects to benefit from a recently signed distribution agreement with Pfizer. Live Nation is the global leader in the production of live concerts and benefits even further through ticketing services offered by its subsidiary, Ticketmaster. CTRP International is a China-based provider of online travel services.
In contrast, the five largest detractors from absolute performance were Tesla, Evolent Health, Restoration Hardware (RH), Ligand Pharmaceuticals, and Herbalife Nutrition. Collectively, these five detracted 26 basis points from performance. Tesla, which was the largest contributor to absolute performance in 2018’s fourth quarter after exceeding production estimates, detracted 15 basis points from performance during 2019’s first quarter due to uncertainty surrounding Model 3 production schedules. The cumulative detraction effects of 11 basis points from Evolent Health, a payment software provider; Restoration Hardware, a distributor of home furnishings; Ligand Pharmaceuticals, a molecular biopharmaceutical company; and Herbalife Nutrition, which operates as a nutrition company, were nominal.
Similar to most of 2018, the continued strength in new-issue activity provided opportunity to further diversify the Fund through selective purchases. We participated in eight of the 25 new issues that came to market, combining for an average weight of 4.90% of the Fund and contributing 18 basis points to absolute performance during the quarter. Such purchases included Fortive, a diversified industrial company focused on instrumentation, automation, and sensing technologies; FTI Consulting, a provider of corporate finance, restructuring, and technology consulting services; Tabula Rasa, a provider of software solutions that enable health care organizations to optimize medication regimens; and Conmed, a health care company focused on the manufacturer of surgical instruments and systems. In addition, for the purpose of rebalancing in a strong equity environment, we added new issues from currently held, deeper-in-the-money tranches from Chegg, an online educational platform; the aforementioned Exact Sciences; and IQIYI, a China-based provider of video entertainment services. Also, in an effort to extend optionality, we swapped into longer dated issues of existing issues from Ares Capital, a business development company focused on the middle markets; and Qiagen, a Netherlands-based global provider of life science equipment used in DNA research.
There were no significant changes in the Fund’s composition during the quarter. The top three industry weightings, software, semiconductors and semiconductor equipment, and internet and direct marketing retail, remained the same quarter-over-quarter. Together, they contributed 363 basis points to absolute performance during the quarter. There was also no material change in Fund positioning relative to the benchmark. The Fund’s two largest sectors, Information Technology and Health Care, together represented 51.5% of the Fund on December 31, 2018, versus 51.4% on March 31, 2019. In the benchmark, Information Technology and Health Care together accounted for 56.2% on December 31, 2018, and 56.5% on March 31, 2019.
During the quarter, the Fund’s underlying convertible valuations underwent a decided shift, reflecting the pickup in market volatility and the subsequent market rebound, and resulting in a more balanced profile. The average weighted investment premium of the Fund was calculated at 28.32% on March 31, 2019, versus 19.73% on December 31, 2018. During the same time, the average weighted underlying equity premium contracted from 50.04% to 38.81%. The impact of this shift enabled the Fund to better take advantage of the recovery in underlying equities while at the same time continuing to maintain a positive risk/reward profile. As the markets have continued to assimilate overall economic and political concerns, we believe the convertible market can continue to focus on the growth attributes for underlying equities, given the overall stability in fundamental credit metrics. We also believe that any renewed pickup in volatility could provide market participants with multiple entry point and rebalancing opportunities.
The convertible new-issue market, after a typical seasonally slow start to the year, saw 25 deals raising $10.5 billion during the first quarter. Redemptions totaled $10.1 billion, with scheduled maturities and debt repurchases accounting for the majority. With annual average issuance of 112 deals totaling $41.9 billion over each of the last three years, market expectations remain constructive for continued strength in the calendar. Catalysts for new-issue activity include the continued strength in underlying equity prices, an apparent supply/demand imbalance, and the potential for higher interest rates.
Looking forward, similar to the start of 2019, we believe that the overall prospects for convertible securities remain positive. The prospects include a growth-oriented equity environment, positive overall credit conditions, increased new-issue activity, and a historical non-correlation to rising Treasury rates.
As we have experienced a period of interest rate uncertainty, with associated intermittent periods of volatility, we believe the market may be more likely to favor more balanced convertible securities with a positive credit profile.

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.