"We believe the Fund is populated with many strongly positioned international growing businesses, with the potential to deliver an attractive growth profile over the next five to 10 years."- Baillie Gifford Overseas Limited
Market in Review
For anyone with an interest in politics and the economy, which includes most of us with an interest in investing and stock markets, the third quarter of 2019 felt like a tumultuous period in the U.S. and on the international stage. From the chaotic Brexit saga, with the U.K. government lurching from one constitutional and political crisis to the next, to the troubling shooting of young protestors in Hong Kong, through to the impending impeachment proceedings in the U.S., the normal rules of politics seem to be upended. Throw into this mix the remarkable sight of U.S. interest rates being cut twice in succession — almost unthinkable even just a few months prior — and a further escalation of U.S.-Chinese trade tensions. Bond yields fell to ultra-low levels, and unusual patterns developed in longer-dated bond yields which, according to some, might indicate darker economic clouds ahead. Even more than usual, it feels that we live in interesting (and uncertain) times.
It might feel a little surprising, therefore, that this has been a rather quiet period for equity markets. International stock markets, as measured by the MSCI All Country World Ex. US Index, delivered a modest negative return. This was slightly inferior to the modest positive returns from U.S. equities, in part owing to the ongoing strength of the U.S. Dollar against most other major currencies. This quarter did not move the needle much, but it continued to expand the striking divergence between U.S. and international equity returns, which has been such a feature of the past five years. As odd as it may sound, we do not believe that the macro environment had a pronounced impact on the Harbor International Growth Fund during the quarter, and we have not revised our long-term ambitions for the Fund’s holdings.
In the third quarter of 2019, the Harbor International Growth Fund (Institutional Class) returned -1.22%, outperforming its benchmark, the MSCI All Country World Ex. US (ND) Index, which returned -1.80%.
Returns were generally muted across the Fund, but a number of semiconductor-related holdings continued to build on their recovery in 2019. Names ranging from TSMC, the large Taiwanese foundry business, to the Dutch lithography specialist ASML and SMC, the Japanese manufacturer of sophisticated industrial equipment with a significant look-through exposure to semiconductor end markets, all made welcome contributions.
While Brexit continued to dominate European news, the Fund’s U.K. holdings were broadly flat in U.S. Dollar terms. This may be simply because "the market" is unsure what Brexit outcome to factor into prices, but we believe that the Fund’s U.K. holdings should be relatively well insulated from Brexit, whatever the outcome, as their long-term growth prospects are dependent on factors other than the domestic economy.
Contributors and Detractors
The Indian paint company Asian Paints was among the largest contributors to performance during the quarter, as the share price bounced back following weakness earlier in the year. Shares of Asian Paints trade at a high multiple of current profits, and demanding valuations can make share prices sensitive to changes in sentiment and profit predictions in the short-term. We think that the picture is much clearer over longer time periods. The company is growing the volume of paint it sells by approximately 10% every year and has a dominant share of formal paint sales in India. Its network of 60,000 stores gives it a significant distribution advantage over the competition, and we believe the company could continue to grow as more people join the middle class in India, increasing demand for Asian Paints’ broadening range of products which now include luxury wood coatings and specialty domestic paints.
Mettler Toledo, the precision measuring equipment specialist serving laboratories and other industrial end markets, was a notable detractor. In our view, operating performance continues to be reassuringly steady, and we believe the share price wobble has more to do with profit-taking after a very strong run. Mettler Toledo has not been helped, however, by what we consider to be a questionable attack from a short seller who made various allegations, broadly around a "too good to be true" theme, with the hope of making a profit from any subsequent share price fall. We have engaged with the company on all these matters and, while any business can always improve on aspects of governance, we believe this is a conservatively managed business with good long-term compounding growth potential ahead.
Buys and Sells
We sold our position in the Chinese e-commerce company JD.com, the second largest competitor in the space to Alibaba. For many years JD.com benefited from its particular strength in logistics in delivery, a strength which has, over time, been eroded by Alibaba’s investment in improved logistics and fierce competition in online retail. We have also become increasingly concerned about the company’s aspirations to expand the business internationally and its CEO’s style of management. There were no new buys during the quarter.
The Fund’s country allocation was broadly unchanged during the quarter. Sweden, India, and Japan remained overweight positions, and France, Canada, and South Korea remained underweight positions. The largest single move was a reduction in the overweight position to Japanese stocks, as a result of a small number of reductions to position sizes. As we often do, we take this opportunity to remind you that we take a bottom-up approach to portfolio construction, so any changes to country allocations are generally an output of individual stock decisions.
We reduced the Fund’s exposure to emerging markets during the quarter. We made two complete sales during the quarter and both happened to be emerging markets listed stocks: JD.com and Hon Hai, the Taiwan-listed electronics assembly business.
After a tricky end to 2018, the first nine months of 2019 have generally been encouraging. There may be a few anxieties around some gloomier economic indicators in Europe in particular, as some weakness in manufacturing spreads into other areas. Specifically in the U.K., there are obvious short-term uncertainties regarding the current political chaos around the Brexit process, and risks of turbulence in the coming weeks and months, depending on how those political cards fall. Nevertheless, we believe the Fund is populated with many strongly positioned international growing businesses, with the potential to deliver an attractive growth profile over the next five to 10 years. In our view, fundamental company strengths could come to dominate and drive attractive financial returns in the years ahead.
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.