Harbor Capital Appreciation Fund Commentary for the Second Quarter: A Sna

“Mid-year, markets continue to focus on and reward companies that generate above-average growth.”

Jennison Associates, LLC

Market in review

In the second quarter of 2024, U.S. economic activity remained resilient, outpacing most economies outside the United States. Evidence of an expected slowdown in growth began to emerge, with consumer confidence declining and the unemployment rate rising modestly through the end of the quarter. The level of the federal funds rate remained steady, reflecting the continued strength of the economy, as policymakers waited for further evidence of softening before taking action.

Meanwhile, elections in India and Mexico produced unexpected results globally. Political leaders in France and the United Kingdom called early elections, leading to uncertainty and market weakness at the end of the quarter. The ongoing conflict in Ukraine, coupled with extensive Israeli military activity, kept geopolitical tensions high. The fallout from a weak real estate market and trade restrictions on technology goods caused Chinese economic activity to stagnate.

Market conditions had no material impact on the Port Capital Valuation 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 application development to monetize AI investment spending weighed on the valuations of several Software as a Service (“SaaS”) companies. However, we remain encouraged that these companies are working on AI initiatives that will enhance their current offerings and fulfill the goal of AI enhancements that will help drive revenue growth for customers over our investment 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 led to uneven — and in some cases challenging — fundamental performance since the start of the year. Several casualties of these trends, along with disappointments on the execution front, have appeared in the athleisure and apparel categories. On the other hand, consumers continue to express a strong preference for travel, with healthy activity levels around the world.

Portfolio performance

During the quarter the Port Capital Valuation Fund (Trades, Portfolio) (Trades, Portfolio) (Institutional Class) returned 6.50%, underperforming the 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 had the largest negative impact on relative performance over the period. Stock selection within the Health Care and Consumer Staples sectors, together with an underweight in Industrials, was beneficial to relative performance.

Contributors and opponents

NVIDIA (NVDA, Financial) contributed to the Fund’s performance as it continues to beat expectations. Demand for the company’s graphics processing units (“GPUs”) continues to be fueled by growth in the AI ​​market. Apple also contributed to performance, as the pace of execution in AI — and optimism about what the company could introduce — drove its stock higher.

Shares of Advanced Micro Devices (AMD, Financial) detracted from performance in the quarter. Field inventory adjustments remained a headwind and the company is also experiencing supply constraints on key products. Salesforce shares also fell after modestly disappointing revenue growth in the latest quarter, as it cited longer sales cycles, a “measured buying environment” and concerns that increased capital expenditures will lead to lower 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 to come. In the meantime, the industry should emerge from the post-COVID-19 cyclical downturn.

We sold our position in UnitedHealth Group (UNH, Financial) amid concerns about the sector’s medical loss ratios, Medicare Advantage and potential impact on growth rates.

Overweight and underweight

Sector weights as a byproduct of our research-driven stock selection. As of 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 broadly stable and directionally consistent.

Perspective

As we enter the middle of the year, markets continue to focus on and reward companies that are generating above-average growth rates. Earnings are generally growing faster than last year and the economy has remained largely resilient. As a result, the federal funds rate remains unchanged from the start of the year. We continue to believe that the trajectory of short-term rates will be lower, although the timing of the move remains uncertain. The consumer slowdown is increasing but does not signal acute distress. Strong employment and rising wages are likely to continue to support a positive backdrop, although earnings moderate over the remainder of the year.

Market concentration is both a real and growing phenomenon. The recently completed Russell 1000® Index reform has exacerbated the situation, with the top 10 constituents now accounting for over 60% of the total weight of the Russell 1000® Growth Index. The challenges are compounded by the fact that the index has fewer than 400 issuers, the lowest number of holdings since 1990. As active large-cap growth investors seeking to manage a diversified fund, we must recognize these realities against this backdrop.

We have positions in several of the largest market-cap companies that — after significant appreciation over the years — are approaching 10% of the fund. Yet in some cases they are below weight in the benchmark. Expressing high conviction through large positions has been a normal practice in our history and an important source of investment alpha. However, idiosyncratic risk contributes significantly to the overall fund risk. As a fiduciary, we value risk management when thinking about the construction of the fund — and what it takes to build a fund that is appropriately balanced for the environment we see going forward, supporting our goal of outperforming the benchmark over time.

Retirement Class Shares were issued on March 1, 2016. Performance attributed to Retirement Class Shares prior to that date is that of Institutional Class Shares. Performance prior to March 1, 2016 has not been adjusted to reflect the lower cost of Retirement Class Shares. During this period, Retirement Class Shares would have had a return similar to, but slightly higher than, Institutional Class Shares because Retirement Class Shares represent interests in the same portfolio as Institutional Class Shares but are subject to lower costs.

Expense ratio information is from the Fund’s current prospectus, as supplemented. Gross expenses are the total annual operating expenses of the Fund. The net expense ratios for this fund are subject to a contractual management fee waiver and/or expense limitation agreement, excluding interest expenses and acquired fund expenses and expenses (if applicable), through 28-02-2025.

The performance data shown is based on past performance and is not a guarantee of future results. Past performance excludes management fees and expenses and reflects reinvested dividends and distributions. Past performance reflects the favorable effect of any waivers or refunds of fees, without which returns would have been lower. Investment returns and principal values ​​will fluctuate and, upon redemption, may be worth more or less than their original cost. Returns for periods shorter 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.