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Sydnee Gatewood
Sydnee Gatewood
Articles (2199) 

Spiros Segalas' Harbor Capital Appreciation Fund 2020 Semi-Annual Letter

Discussion of markets and holdings

MARKET REVIEW

The six-month period saw two distinct environments. From November through mid-February, global equity markets advanced solidly, reflecting reaction to the U.S. Federal Reserve’s rate cut in October and the announcement of a framework agreement that brought relief from U.S.-China trade war anxiety. The U.S. economy was proceeding along a steady path of 1.5%-2.0% growth, with unemployment at record low levels. Stocks peaked at new highs on February 19, then dropped more than 30% in only 25 trading days, as the COVID-19 outbreak spread rapidly around the globe, disrupting markets and life virtually everywhere. Exacerbating the turmoil, Saudi Arabia and Russia declared an oil price war, causing energy prices to plummet. Policy makers responded to these events with historic monetary and fiscal actions. Markets regained ground in April although the ultimate magnitude and scale of the pandemic remain unknown, making the near-term and intermediate outlook highly uncertain.

PERFORMANCE

The Harbor Capital Appreciation Fund advanced 10.58% (RetirementClass), 10.54% (Institutional Class), 10.41% (Administrative Class), and 10.34% (Investor Class) in the six months ended April 30, 2020, outperforming the Russell 1000®Growth Index, which rose 6.09%.

In the benchmark index, the Information Technology, Consumer Discretionary, Health Care, and Communication Services sectors advanced. Energy declined more than 30%, while Industrials fell 15%.

Positions in the Fund’s heaviest-weighted sectors — Information Technology, Consumer Discretionary, and Communication Services — outperformed largely on favorable stock selection. Industrials holdings declined materially.

Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN) were key positive contributors to Fund return. Both have secular growth profiles that we believe look even stronger, as social-distancing and shelter-in-place directives are drawing renewed attention to the value, utility, and resilience of ecommerce and video streaming business models. Recognition of the importance of digital commerce in times of restricted personal mobility also benefited Shopify (SHOP), which provides cloud-based, easy-to-use infrastructure tools and an omni-channel ecommerce capability.

The COVID-19 pandemic has highlighted the prudence – and in many cases, the necessity– of working from home or at other offsite locations and by extension, the advantage of housing mission-critical software applications and services on the cloud. In addition to a strong and stable enterprise business, Microsoft (NASDAQ:MSFT) has a differentiated hybrid cloud strategy that is leading to an increase in its share of technology capital spending. Coupa Software (NASDAQ:COUP) is a leader in cloud-based spend-management software that simplifies corporate procurement, invoicing, and expense management. The markets in which Coupa competes are large and well-established, and the company has added new customers at an accelerated rate over the past several years.

In our view, Nvidia (NASDAQ:NVDA) is focused on key high-growth markets where it can leverage its graphics semiconductor expertise to offer high-value-added solutions. Strong growth in its data center business is likely to continue as increased demand for cloud storage prompts robust spendingby Nvidia’s data center customers.

Payments processors saw mixed results. Adyen (XAMS:ADYAN), a global digital payments company, has developeda single, dynamic, reliable, and secure payment platform that supports omni-channel commerce with end-to-end gateway, risk management, and processing services. FleetCor (NYSE:FLT), which provides charge cards and payment-processing services for trucking fleets, fell on litigation related to its marketing and fee practices and on exposure to oil prices.We eliminated the position in Square (NYSE:SQ) based on its exposure to small business activity, which could be materially curtailed,and in some cases, permanently lost, by prolonged COVID-19-related business closures.

In Consumer Discretionary, Tesla (NASDAQ:TSLA), which had been controversial over much of the past year, surged early in 2020 on strong earnings, revenue, and free cash flow made possible by solid production, increased capacity, and strong execution. We eliminated the position in Adidas (XTER:ADS) based on the company’ssofter-than-expected gross margin, COVID-19-related sporting event cancellations, and an anticipated back-up in wholesaleinventories. Marriott International (MAR) declined on lackluster revenue per available room and exposure to COVID-19’s impact on global travel and tourism.

In Health Care, DexCom (DXCM) is a technological leader in continuous glucose monitoring (CGM) systems that eliminate the needfor people with diabetes to test their blood glucose levels throughfinger sticks. As CGM penetration is in its nascent stages, the market has significant room to grow. In our view, Vertex Pharmaceuticals (VRTX) is growing through the expansion of itstreatments for cystic fibrosis, a life-threatening genetic disease. Eli Lilly (LLY) has diversified its core diabetes and central nervous system/psychiatric treatments business to include immunology and oncology products. Product mix shifts are expected to expand margins. We trimmed positions in Intuitive Surgical (ISRG) and Illumina (ILMN), whose products and revenues are dependent on capital equipment expenditures or government funding.

In Industrials, the longer-than-anticipated 737 Max 8 jet recertification process weighed on Boeing (BA) early in the period. With the COVID-19 outbreak severely restricting air travel and compromising the financial health of airlines, we reduced the position. The positions in Airbus (XPAR:AIR) and Safran (XPAR:SAF), which makes aircraft engines, were eliminated.

OUTLOOK & STRATEGY

As a fundamental investor, we examine company and industry prospects over the short and long term, working to understand how industries and businesses will change over time. Investing in companies with well-above-average long-term growth ratesand unique, market-leading products and services remains our focus.

Spiraling COVID-19 infection rates, economic lockdowns, and social distancing initiatives have caused a spike in unemploymentand a sharp drop in gross domestic product (GDP) worldwide. Historically massive fiscal and monetary stimulus measures have been implemented rapidly, but we believe that additional fiscal measures will likely be necessary and forthcoming. The ultimate magnitude and scale of the pandemic remain unknown, making the near-term and intermediate outlook highly uncertain. Greater clarity about the impact depends on progress in diagnostics, therapeutics, and vaccines.

Underlying conditions before the outbreak were largely solid, with fundamentally healthy economic structures. However, we do not expect recovery to be uniform, and unemployment may be higher than normal for some time.

The Fund includes the stocks of businesses that, in our view lead their industries and grow at faster rates than the market average. We believe that companies held in the Fund also generate significant cash flow, which may allow them to weather difficult times and sustain the competitive advantages necessary to create true economic value over the long term.

  1. 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 potentially 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.

This report contains the current opinions of Jennison Associates LLC as of the date of this report and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Such opinions are subject to change without notice and securities described herein may no longer be included in, or may at any time be removed from, the Fund’s portfolio. This report is distributed for informational purposes only. Information contained herein has been obtained from sources believed reliable, but not guaranteed.

Equity securities, such as common stocks, are affected by company specific events and by movements in the overall stock markets in which those securities principally trade, among other factors. An adverse company specific event, or downturn in those stock markets, can depress the value of a particular company’s equity securities.For information on the different share classes and the risks associated with an investment in the Fund, please refer to the current prospectus.

About the author:

Sydnee Gatewood
I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech University. I have lived in Texas most of my life, but also have roots in New Mexico and Colorado. Follow me on Twitter! @gurusydneerg

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