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High-Yield Opportunities Fund —
Fourth Quarter Manager Commentary
4th Quarter, 2018
"We maintain a constructive outlook on below investment grade corporate credit fundamentals. "

Economic Overview
The financial markets remained under pressure in the fourth quarter of 2018 amid persistent uncertainties surrounding unresolved trade issues between the U.S. and China, geopolitical risks involving Saudi Arabia, Italy’s budget concerns, Brexit, and slowing global growth, particularly in Europe and emerging markets. The markets sold off materially, and the sentiment turned grim amid significant volatility. The Federal Reserve’s monetary policy also played a significant role in the markets and produced volatility in Treasury yields. The Federal Open Market Committee raised the federal funds rate by 0.25% at its December meeting, in line with expectations, but lowered its predictions to two rate increases from three in 2019. The fourth quarter also saw heavy withdrawals from U.S. high yield mutual funds.
Portfolio Review
The Harbor High-Yield Opportunities Fund (Institutional Class) returned -5.46% for the fourth quarter of 2018 while the ICE BofAML US High Yield Index (H0A0) returned -4.67%, underperforming the benchmark by 79 basis points.
The Fund’s underperformance was attributable to CCC Energy names that were under pressure given the sharp decline in oil prices during the quarter. Crude oil declined by 38% since the end of last quarter, ending the fourth quarter at $45 a barrel. As a result, the Energy sector was the worst performing sector returning -9.76% in the quarter. The Fund’s overweight positioning and weak security selection in the Energy sector was the biggest detractor from relative performance. To a lesser extent, the overweight positioning and weak security selection in basic industries also detracted from relative performance. Conversely, the Fund benefited from strong security selection in the Services and Financial Services Sectors. In terms of credit quality, weak security selection in the CCC –rated and BB – rated credit tiers detracted from performance, while strong security selection in the B- rated credit tier was accretive to relative performance.
Among the largest detractors for the Fund in the fourth quarter were Sanchez Energy, Weatherford, Jones Energy, and California Resources. Sanchez Energy and Jones Energy underperformed as the sharp sell-off in commodity prices raised concerns about each company’s ability to service its sizeable debt burdens and increased the odds of potential restructurings. Although Weatherford’s headline earnings for the third quarter again beat expectations, the company continued to burn through its cash more quickly than expected, which put downward pressure on prices of the company’s bonds early in the fourth quarter. The weakness was further exacerbated by the subsequent collapse in commodity prices that occurred throughout the rest of the quarter and pressured the entire Energy sector. Despite materially improved financial flexibility and strong quarterly earnings that beat expectations, California Resources bond prices have historically been highly correlated to crude oil prices and as such, trading levels were also pressured by the sharp decline in commodity prices during the quarter.
Among the largest contributors for the Fund in the fourth quarter were Cardtronics, Talen Energy, and Salem Media Group. Cardtronics bonds initially gained positive momentum following solid third quarter 2018 earnings that beat consensus forecasts, and in tandem with which the company raised its full-year revenue and earnings guidance. Subsequently, the bonds rallied sharply on news that the company would be calling the bonds prior to maturity with the proceeds from a new revolving credit facility. Talen Energy bonds also outperformed, as quarterly earnings exceeded expectations and the company increased its full-year 2018 earnings guidance. Salem Media Group bond prices moved higher primarily due to quarterly earnings that beat expectations.
During the year, we reduced the Fund’s exposure to the CCC-rated credit tier and added to the B-rated tier. We also reduced exposure to commodities-related sectors such as Energy and basic industries, moving from an overweight position versus the benchmark at the start of 2018 to an underweight position by the end of the fourth quarter. We have also been reducing the duration gap between the Fund versus its benchmark, as we believe the Fed will pause or slow the pace of interest rate increases in the next few quarters as a result of a tightening of credit conditions and increased market volatility, combined with signs of slowing economic growth.
A continuation of the status quo for the U.S. economy seems the most likely scenario at the present time, in our opinion. With Gross Domestic Product (GDP) likely, in our view, to grow at 2.5% to 3.0% per year, we believe that there’s neither concern about a recession nor overheating in the near term. We maintain a constructive outlook on below investment grade corporate credit fundamentals. Strong earnings growth in most sectors has been tempered by weak technical factors such as consistent high yield fund outflows and concerns surrounding Federal Reserve rate actions.
Our view on valuation in the high yield sector has become more positive as the yield on the asset class exceeded 7.9% as of the end of 2018. We believe defaults are likely to remain low and come in below 3.0% in 2019, well below the historical average of 4.1%. The fundamentals in the U.S. high yield space remain strong, in our opinion. Company balance sheets are getting stronger, we believe, and leverage ratios are declining among noninvestment-grade companies. In response to the recent market sell-off, with wider spreads and lower Treasury yields, many sell-side analysts are now revising their 2019 return forecasts upward, noting the improved return profile offered in the U.S. high yield space. While we do not foresee any major fundamental concerns for the asset class, we believe Fed rate actions, oil price volatility, and rising risks of a global trade war deserve close monitoring.

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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.