MARKET REVIEW
Markets were extremely volatile in the period, unsettled by U.S.-China trade discord and the COVID-19 pandemic.
Stocks peaked at new highs in early 2020, then dropped dramatically as the viral outbreak spread around the globe, disrupting markets and life everywhere.
The realities of the pandemic dictated daily conduct for individuals, businesses, and governments around the world. Shelter-in-place and work-from-home became standard. Global infection and mortality rates reflected varying policy and social behaviors, with the number of infections and deaths highest in the U.S. Developing a vaccine became an overwhelming focus, with both human and capital resources deployed.
Markets rebounded rapidly in the period's final months, but the pandemic's economic damage continued to accumulate.
The effects of fiscal stimulus blunted the pandemic's effect on employment and spending. Comprehensive monetary policy initiatives to bolster liquidity and stabilize asset prices contributed to record-low interest rates.
PERFORMANCE
Harbor Capital Appreciation Fund advanced 42.79% (Retirement Class), 42.68% (Institutional Class), 42.32% (Administrative Class), and 42.15% (Investor Class) in the fiscal year, while the Russell 1000® Growth Index rose 29.22%, and the broader market, as represented by the S&P 500 Index, climbed 9.71%.
In the growth benchmark, the Consumer Discretionary, Information Technology, and Communication Services sectors outperformed the overall Natasha Kuhlkin, CFA index. Energy posted a double-digit decline. Industrials was the onlyother sector in the benchmark to lose ground.
Stock selection and sector weights benefited Fund performance relative to the growth benchmark. Holdings in Consumer Discretionary, Information Technology, and Communication Services– the Fund's three biggest sectors – were especially strong contributors to outperformance as both stock selection and overweights were beneficial.
In Consumer Discretionary, Tesla (TSLA, Financial) continues to surge on a host of impressive financial results made possible by solid production, increased capacity, and strong execution. In our view, the company's technology, scale, and low-cost advantage make it not only the breakaway leader in the electric-vehicle market but also position it to disrupt the overall automotive industry. Consumer businesses that have migrated to digital direct-to-consumer business models were notably strong performers. Amazon (AMZN, Financial) has operated in this mode for years, and its relevance and dominance became even more apparent. We believe that Amazon continues to benefit from economies of scale and its platform-based business model. The AWS web services business is a significant additional driver of revenue and profit for Amazon. Apparel retailer Lululemon Athletica (LULU, Financial) benefited from less-seasonal offerings, strong brand, and a direct-to-consumer infrastructure that shields it from wholesale distribution backlogs and increased levels of price discounting.
In Information Technology, digital payments processors were strong performers. Adyen (XAMS:ADYEN, Financial) has developed a single, dynamic, reliable, and secure payment platform that supports omni-channel commerce with end-to-end gateway, risk management, and processing services. PayPal (PYPL, Financial) is the largest ecommerce payments enabler in the U.S. and many developing countries. We believe that PayPal can deepen and extend its services among global, consumer, and business clients. The importance of digital commerce in times of restricted personal mobility is also benefitting Shopify (SHOP, Financial), which provides cloud-based, easy-to-use infrastructure tools to enable omni-channel ecommerce capability.
With millions of people around the world working from home, the advantage of housing mission-critical software applications and services on the cloud has emerged. In addition to a strong and stable enterprise business, Microsoft (MSFT, Financial) has a differentiated hybrid cloud strategy that is leading to an increase in its share of technology capitalspending. Its Azure cloud business hosts Microsoft softwareas well as hundreds of cloud-native applications that Microsoftcustomers or third parties create. The company's Teams collaboration platform is also benefitting from increasedwork-from-home requirements. Adobe (ADBE, Financial) offers content creationand digital marketing applications and services that aretransforming businesses operations. Salesforce (CRM, Financial) remains at the forefront of migrating traditional customer records systemsto comprehensive customer intelligence systems. Even in theface of unpredictable macroeconomic trends, in our view,enterprises are concluding that the financial benefits deliveredby Salesforce offset the capital outlay required for softwarepurchase and deployment.
The increased demand for cloud storage has led to robust datacenter spending by chipmaker Nvidia's (NVDA) largest customers. Nvidia's acquisition of Mellanox (MLNX) could enhance its functionalityand potentially lead to further share gains in the data centerspace, in our view.
With its huge installed base, Apple (AAPL) has been benefiting from rapid growth in service business subscriptions, a key source of recurring revenue. In our view, the upcoming product cycleshould provide robust revenue and profit growth.
In Communication Services, Netflix (NFLX) continues to enhance its long-term competitive position with the industry's largest commitment of investment dollars in exclusive and original content. Given its still-low global penetration and the accelerating shift from linear TV, we believe that Netflix still has significant room for growth. The company's secular growth profile looks even stronger in the current environment, associal-distancing and shelter-in-place directives are drawing renewed attention to the value, utility, and now, resilience,of video streaming business models.
Industrials positions detracted from performance. The longer-than-anticipated Boeing 737 Max 8 jet recertification process weighed on Boeing (BA) early in the period. With the COVID-19 outbreak severely restricting air travel andcompromising the financial health of airlines, the position was eliminated. The position in Safran (XPAR:SAF) was closed based on the company's exposure to the airline industry. Most of Safran's revenue is generated by its aerospace propulsion business, whichincludes the company's joint venture with General Electric (GE), which makes 75% of the world's narrow-body aircraft engines(including all of Boeing's 737s and about half of Airbus's A320s).
In Consumer Discretionary, the position in Adidas (XTER:ADS) was eliminated based on the company's softer-than-expected gross margin, COVID-19-related sporting event cancellations, and an anticipated back-up in wholesale inventories.
In Information Technology, the position in FleetCor Technologies (FLT), which provides specific-purpose charge cards and payment-processing services for commercial andgovernment trucking fleets, was eliminated based on the impactof regulatory litigation related to the company's marketing and fee practices, as well as on exposure to oil prices.
In Health Care, the position in Sage Therapeutics (SAGE) was closed as a Phase 3 clinical trial of its key developmental therapy to treat major depression (MDD) failed to meet the study's primary endpoint. The MDD market opportunity was expected tobe a key component of the company's growth.
OUTLOOK & STRATEGY
The U.S. economy continues to recover from the worst effects of the pandemic, but the pace of the rebound appears to be moderating. Congress has so far failed to agree on additional stimulus to take up the slack from the massive, but now-largely-exhausted, programs approved in March.
Investors have demonstrated their preference for businesses that were thriving before COVID-19 and that have benefitted from pandemic-related tailwinds and enhanced competitive positions. The Fund holds many companies across the technology, consumer, and communications services industries in this category. In our view, prospects for these companies' continued growth at above-average rates remain strong.
- 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.
Performance data shown represents past performance and is no guarantee of futureresults. Past performance is net of management fees and expenses and reflectsreinvested dividends and distributions but does not reflect the deduction of taxesthat a shareholder would pay on Fund distributions or upon the redemption of Fundshares. Past performance reflects the beneficial effect of any expense waivers orreimbursements, without which returns would have been lower. Investment returnsand principal value will fluctuate so that Fund shares, when redeemed, may be worthmore or less than their original cost. Returns for periods less than one year are notannualized. Current performance may be higher or lower and is available throughthe most recent month end atharborfunds.comor by calling 800-422-1050.
