"We have always looked to invest in businesses with fundamentals underpinned by secular growth."- Sands Capital Management, LLC
Market in Review
Global growth uncertainty continues to rise, with many investors anticipating the end of the longest economic expansion in U.S. history, as well as heightened political uncertainties such as trade tensions between the U.S. and China and a potentially contentious U.S. presidential election next year. As a result, we have seen business confidence drop and analysts pare back profit expectations. In addition, it appears there has been a rotation into traditionally defensive assets, and a shift away from focusing on business fundamentals, particularly over a longer time horizon. Thus, we believe growth concerns are once again at the core of the disconnection between businesses’ share prices and fundamentals.
Underneath the challenging economic and geopolitical backdrop, we continue to see very powerful secular trends that are being driven by a small subset of the businesses in the world. These businesses are either creating or benefiting from those disruptions. We have always looked to invest in businesses with fundamentals underpinned by secular growth. Many of these businesses are selling 'needs' and not ‘wants’ to their customers, or are benefiting from very durable, long-term structural changes happening around the world.
In the third quarter of 2019, the Harbor Global Leaders Fund (Institutional Class) returned 1.41%, outperforming its benchmark, the MSCI All Country World (ND) Index, which returned -0.03%.
The U.S. and Canada were the top regional contributors (driven by selection effect), while developed Asia was the main detractor due to economic and political unrest in large markets. Fundamentally, however, the businesses owned within developed Asia remain strong and continue to benefit from durable secular tailwinds.
From a sector perspective, Consumer Discretionary and Industrials were the largest contributors to absolute and relative results, while Financials and Consumer Staples detracted the most.
Contributors and Detractors
The largest contributors to relative results during the quarter were TransDigm, Dollar General, Texas Instruments, Zoetis, and Taiwan Semiconductor. Dollar General is the largest small-format discount retailer in the U.S., with over 15,000 stores in more than 40 states. The company’s most recent quarterly results impressed us, with sales and earnings ahead of both consensus and our expectations. Continued increases in average transaction sizes and customer traffic resulted in annual same-store-sales growth of four percent, the highest comparable-store growth in over five years. Gross profit margins improved modestly, as management maintained strong cost controls and reduced the overall pace of markdowns. In addition, management returned more than $260 million in capital to shareholders in the form of dividends and share buybacks. These quarterly results demonstrated that the company is capable of increasing profit growth and returning capital to shareholders, while maintaining a strong new-store opening trajectory.
The largest detractors from relative investment results during the quarter were HDFC Bank, AIA, Recruit, Adobe, and Dassault Systèmes. HDFC Bank is India’s largest private-sector bank, with a customer base of approximately 40 million. The company’s share price was pressured as the Indian economy showed signs of weakness—Gross Domestic Product (GDP) growth during the quarter was the lowest in more than five years. In its recent quarterly report, HDFC Bank reported weaker-than-expected loan growth and cautious guidance around credit risks, given the weak macro environment. As the largest listed financial services company in India by market cap, HDFC Bank share price also faced pressure from fears that some financial firms could fail, and that this could affect the broader banking industry and Financials sector. These fears were triggered by negative reports on several Indian companies, including one that is curtailing operations after authorities uncovered several instances of accounting fraud and corruption. However, HDFC Bank’s share price has fared relatively better in this environment, as it has largely avoided lending to the most distressed financial and non-financial corporations over the last year. We believe that in the medium- to long-term, the general concerns around some of the smaller Indian banks and non-bank financial services companies should benefit HDFC bank, as investors become more risk averse and seek more safety and higher quality. Stepping back from the broader industry concerns, we believe HDFC Bank is well positioned for the medium-to long-term, as we anticipate that the Indian economy can deliver real GDP growth between five and seven percent, and that the salaried middle class, which forms HDFC’s main customer base, will likely continue to expand over time.
Buys and Sells
We purchased IQVIA in August. IQVIA is a leading contract research organization and health care IT service provider worldwide. The company offers outsourced solutions spanning the drug life cycle to pharmaceutical and biotech companies. IQVIA is capitalizing on a secular shift in biopharma to outsource non-core activities in the effort to mitigate costs and manage risks amid an increasingly complex, competitive, and cost-constrained environment. We believe IQVIA’s key value proposition lies in its unmatched global repository of patient data, which is leveraged by customers to accelerate patient recruitment for clinical trials, a key industry bottleneck, and insights from post-approval studies. We believe IQVIA is best positioned within its industry, as it expands its client base beyond large pharma into emerging biotech and other healthcare segments. Given its leadership and competitive advantages, we believe the company could generate mid-teens earnings growth over our investment horizon.
We purchased Bank Central Asia (BCA) in September. BCA is Indonesia’s largest private-sector bank, and the market-share leader for payment transactions, unsubsidized mortgage lending, and credit card issuance. It operates in what we view as an attractive macro environment, which features relatively low levels of financial penetration (less than 40 percent of Indonesians have a bank account), a large and increasingly urbanized population, strong underlying GDP growth in the mid-single digits over the last decade, and relatively high levels of bank profitability. BCA’s competitive advantage stems from its strong transaction-banking presence, which has enabled it to capture a disproportionate share of sticky, low-cost deposits. We believe the company’s culture of risk management has consistently led to superior asset quality compared to peers, with loan losses of only one percent (on average) through cycles. Additionally, BCA has a strong affiliation with Indonesians of Chinese descent, who are concentrated in urban areas and are disproportionately represented in the country’s small-to-medium enterprises and large corporations.
We sold Salesforce in August. The key driver of our decision to sell was based on portfolio construction rather than a company-specific reason. Within the Fund, we place additional emphasis on the stability and predictability of growth, and aim to maintain a portfolio with a diverse group of growth drivers. In selling Salesforce, we reduced our exposure to the software-as-a-service growth driver. In addition, the Fund owns other software-based businesses that better fit the stability and predictability earnings growth profile that we seek to own.
We sold Alibaba in September. While we do not have any issues with Alibaba’s business, we are reducing our exposure around the debate on the Chinese economy as well as the trade tensions between the U.S. and China. We reallocated to businesses we believe better fit the Fund’s emphasis on stability and predictability of growth.
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.
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 harborfunds.com.
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.