“At the year's halfway point, markets continue to focus on and reward companies that are generating growth at above-average rates.”
Jennison Associates, LLC
Market in Review
The second quarter of 2024 saw continued resilience in U.S. economic activity, as it exceeded the pace of most economies outside the United States. Evidence of an anticipated deceleration in growth began to emerge, with consumer sentiment declining and the unemployment rate increasing slightly through quarter-end. The level of the federal funds rate remained steady, reflecting the ongoing strength of the economy as policymakers awaited further evidence of softening before acting.
Meanwhile, around the globe, elections in India and Mexico produced unexpected outcomes. Political leadership in France and the United Kingdom called snap elections, leading to uncertainty and market weakness into quarter-end. The ongoing conflict in Ukraine, coupled with expanded Israeli military activity, kept geopolitical tensions high. The repercussions of a weak property market and trade restrictions on technology goods saw Chinese economic activity stagnate.
The market backdrop did not have a material impact on the Harbor Capital Appreciation Fund (Trades, Portfolio) (Trades, Portfolio)'s (“Fund”) positions. Accelerated spending on artificial intelligence (“AI”) infrastructure among hyperscalers continued. Near-term disappointment with the pace of developing applications to monetize the spending on AI investments weighed on valuations of several Software as a Service (“SaaS”) companies. However, we remain encouraged that these companies are working on AI initiatives that will improve their current offerings and fulfill the goal of AI enhancements that will help drive revenue growth for customers over our investment time horizon.
Trends in global consumer goods companies remained mixed. Poor consumption trends in China, weaker currencies in other markets, and declines in consumer confidence have resulted in uneven — and in some cases challenging — fundamental performance since the year began. Several casualties of these trends, along with execution-specific disappointments, appeared in the athleisure and apparel categories. On the other hand, consumers are still expressing a strong preference for travel, with healthy activity levels across the globe.
Portfolio Performance
During the quarter, the Harbor Capital Appreciation Fund (Trades, Portfolio) (Trades, Portfolio) (Institutional Class) returned 6.50%, underperforming its benchmark, the Russell 1000® Growth Index, which returned 8.33%, and outperforming the S&P 500 Index, which returned 4.28%.
Stock selection within the Information Technology and Communication Services sectors detracted the most from relative performance during the period. Security selection within the Health Care and Consumer Staples sectors, along with an underweight in Industrials benefited relative results.
Contributors & Detractors
NVIDIA (NVDA, Financial) contributed to the Fund's performance as it continues to surpass expectations. Demand for the company's graphics processing units (“GPUs”) continues to be spurred by growth in the AI market. Apple also contributed to performance, as its pace of execution in the AI field — and optimism about what the company may introduce — propelled the stock price higher.
Advanced Micro Devices' (AMD, Financial) shares detracted from performance during the quarter. Inventory adjustment in the field remained a headwind, and the company is also experiencing supply constraints on important products. Salesforce shares also declined, following modestly disappointing revenue growth in its latest quarter, as it cited longer sales cycles, a “measured buying environment,” and concerns that higher investments will lead to less operating margin leverage.
Buys & Sells
We initiated a position in Analog Devices (ADI, Financial), as the company is well positioned for strong cyclical growth in analog and mixed-signal technology. The company should also benefit from the acquisition of Linear Technology and Maxim for many years. Meanwhile, the industry should be emerging out of its post-COVID-19 cyclical downturn.
We sold our position in UnitedHealth Group (UNH, Financial) due to concerns about industry medical-loss ratios, Medicare Advantage, and potential impacts on growth rates.
Overweights & Underweights
Sector weights as a by-product of our research-based stock selection. At mid-2024, the Fund's largest sector overweights/underweights relative to the Russell 1000® Growth Index were in Consumer Discretionary (overweight) and Information Technology (underweight). Sector weights remained generally stable and directionally consistent.
Outlook
At the year's halfway point, markets continue to focus on and reward companies that are generating growth at above-average rates. Profits generally are growing at a faster rate than during the previous year, and the economy has remained largely resilient. The federal funds rate, as a result, remains unchanged from the start of the year. We continue to believe that the trajectory of short rates will be lower, though the timing of the movement remains uncertain. The consumer slowdown is gathering pace but not suggestive of acute distress. Strong employment and growing wages will likely continue to support a positive backdrop, though with moderating gains over the balance of the year.
Market concentration is both topical and a growing phenomenon. The recently concluded Russell 1000® Index reconstitution has further compounded the situation — the ten largest constituents have risen above 60% of the Russell 1000® Growth Index's total weight. Further intensifying the challenges, the index has less than 400 issuers, its fewest number of holdings since 1990. As active large-cap growth investors with the goal of managing a diversified Fund, we must acknowledge these realities against this backdrop.
We hold position sizes in several of the largest market-capitalization companies that — after significant appreciation over the years — approach 10% of the Fund. Yet, in some cases, they are below the weight in the benchmark. Expressing high conviction through large positions has been a normal course of business over our history and an important source of investment alpha. However, idiosyncratic risk is a significant contributor to overall Fund risk. As a fiduciary, we place value on risk control when thinking about Fund construction — and what it takes to build a Fund with the appropriate balance for the environment we see going forward, in service of our goal of outperforming the benchmark over time.
Retirement Class shares commenced operations on March 1, 2016. The performance attributed to the Retirement Class shares prior to that date is that of the Institutional Class shares. Performance prior to March 1, 2016 has not been adjusted to reflect the lower expenses of Retirement Class shares. During this period, Retirement Class shares would have had returns similar to, but somewhat higher than, Institutional Class shares due to the fact that Retirement Class shares represent interests in the same portfolio as Institutional Class shares but are subject to lower expenses.
Expense ratio information is as of the Fund's current prospectus, as supplemented. Gross expenses are the Fund's total annual operating expenses. The net expense ratios for this fund are subject to a contractual management fee waiver and/or expense limitation agreement, excluding interest expense and acquired fund fees and expenses (if any), through 02/28/2025.
Performance data shown represents past performance and is no guarantee of future results. Past performance is net of management fees and expenses and reflects reinvested dividends and distributions. Past performance reflects the beneficial effect of any expense waivers or reimbursements, without which returns would have been lower. Investment returns and principal value will fluctuate and when redeemed may be worth more or less than their original cost. Returns for periods less than one year are not annualized. Current performance may be higher or lower and is available through the most recent month end at harborcapital.com or by calling 800-422-1050.
