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Convertible Securities Fund —
Fourth Quarter Manager Commentary
4th Quarter, 2018
"Looking forward, similar to 2018, we believe that the overall prospects for convertible securities remain positive. "

Economic Overview
Synchronized global growth at the start of 2018 shifted to fears of a synchronized global slowdown by the end of the year, precipitating investor gloom and doom. During the fourth quarter of 2018, extreme daily volatility appeared amplified by program trading and algorithmic models. Despite rapid global growth, oil prices tumbled. In the U.S., inflation remained subdued, even amid 3% Gross Domestic Product growth and a tight labor market. Despite corporate earnings growth, strong consumer confidence, and job growth, equity valuations plunged during the quarter.
Portfolio Review
In the fourth quarter of 2018, the Harbor Convertible Securities Fund (Institutional Class) returned -7.30%, outperforming its benchmark, the ICE BofAML US Convertible Excluding Mandatory Index, which returned -9.24%.
During the volatile fourth quarter, an underweight position in the most equity-like portions of the market, as is endemic to our investment approach, contributed to relative performance. From an industry perspective, Semiconductors and Semiconductor Equipment, IT Services, and Biotechnology supported relative results. In the Semiconductors and Semiconductor Equipment and IT Services industries, we benefited from underweight positions. In Biotechnology, an overweight position in IONIS Pharmaceuticals Inc., a developer of drugs for unmet medical needs, helped performance, as it announced positive clinical trial results.
The most impactful portfolio decision that benefited performance during 2018 was the decision within the Information Technology sector to continue to emphasize the Software and Internet Software industries and to reduce exposure to Semiconductors. This decision was in response to fears related to China trade-war exposure and the potential slowdown in the sale of mobile devices. The net portfolio contribution effect was positive. It is important to note that we continue to emphasize diversification. At the end of 2017, the combined Software and Internet Software industries held 21 separate positions; at the end of 2018, the total was 28 positions.
The three largest contributors to absolute performance during the quarter were convertible issues of Tesla, Workday, and TWILIO. Tesla’s equity rose 25.7% during the quarter, as it met production targets for its new S3 model, which in turn alleviated capital markets fundraising concerns. Workday Inc., a cloud-based provider of enterprise solutions for human resources and finance, helped performance, supported by an increase in subscription revenue and better-than-expected third-quarter results. Twilio Inc., announced much-better-than-expected third quarter earnings and raised guidance. The company offers a cloud computing platform that helps customers such as WhatsApp, Uber, and Nordstrom weave communication capabilities into services.
In contrast, having no exposure to banks detracted from relative performance during the quarter. The two primary industry constituents, Bank of America Corporation and Wells Fargo & Company, each have outstanding long-dated, deep-out-of-the-money preferred securities that are highly sensitive to moves in U.S. Treasury rates. Stylistically, we avoid such issues.
The three largest detractors from absolute performance during the quarter were convertible issues of DISH Network Corporation, Ligand Pharmaceuticals Inc., and Marriott Vacations Worldwide Corporation. DISH, a provider of direct broadcast subscription television, has been experiencing a negative trend in core subscriber growth amid uncertainty about its ability to monetize its holdings of 5G spectrum. We will continue to monitor the situation. Ligand Pharmaceuticals is a biopharmaceutical company that develops drugs designed to regulate hormone activity. Despite recent strong earnings by the company, there has been some concern over the growth of its royalty pipeline, a situation we intend to closely monitor. Marriott Vacations, a leader in the timeshare industry, has seen recent weakness related to concerns of a global slowdown; however, we believe underlying fundamentals remain strong.
Similar to most of the preceding three quarters of 2018, the continued strength in new issue activity during the fourth quarter provided opportunities to further diversify the Fund’s portfolio through selective purchases. Such purchases included DocuSign Inc., a provider of electronic signature solutions; IQIYI Inc., a China-based provider of video and entertainment services; KBR Inc., a global engineering and construction company providing services to the energy, petrochemicals and government services areas; and Evolent Health Inc., a provider of application software used by health care providers. In addition, we added new issues from previously held, deeper in the money tranches, including Wayfair Inc., an online provider of household goods; and Dexcom Inc., a medical devices company focused on the development of continuous glucose monitoring systems. Also, in the secondary market, we added home products distributor RH and nutrition company Herbalife Nutrition Inc., both due to strong recent earnings trends.
Underlying valuations for the Fund’s convertible securities have undergone a shift as a reflection of the sustained infusion of new issues and recent episodic volatility, resulting in a less equity-like profile. The average weighted investment premium of the Fund was calculated at 19.73% on December 31, 2018, versus 29.12% at December 31, 2017. While at the same time, the average weighted underlying equity premium expanded to 50.04% from 35.21%, year over year. ?
As the markets continue to assimilate overall economic and political concerns, we believe the convertible securities market could continue to focus on the growth attributes of 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 points and rebalancing opportunities.
There has been no material change to our outlook as a result of recent macro events. We believe that uncertainty and periodic volatility in a growth environment tends to favor our strategy by providing numerous opportunities to rebalance the Fund’s portfolio. Looking forward, similar to 2018, we believe the overall prospects for convertible securities remain positive. In our view, the prospects include a growth-oriented equity market environment, positive overall credit conditions and increased new issue activity, combined with a historical non-correlation to rising U.S. Treasury rates. As we experience a period of interest rate uncertainty, with associated intermittent periods of volatility, we believe the market is likely to favor more balanced convertible securities with a positive credit profile.
We believe convertible new issue activity could pick up at any sign of a prolonged backup in the corporate and high yield calendars, as issuers look to take advantage of the opportunity to sell into an apparent supply and demand imbalance. In our view, additional catalysts for convertible new issue activity include a rebound in underlying equity prices and the potential for higher interest rates.

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.