Dear Fellow Shareholder:
Looking back on the past two calendar quarters reveals a tale of two markets. After a strong summer market rally, volatility reemerged last fall, due to continuing investor concerns about the pandemic, increasing political rhetoric, and other geopolitical events. However, the resolution of the presidential election, new vaccine approvals/rollouts, along with the passage of two U.S. fiscal stimulus packages, led to improved investor sentiment and appetite for risk that generated an equity market rally that continued through the first quarter of 2021—although at a slower pace than in the fourth quarter of 2020. U.S. and global equity markets produced positive total returns over the six-month period ended April 30, 2021. The S&P 500 added to its strong performance of 12.15% in the fourth quarter, with a return of 6.17% in the first quarter, outperforming the MSCI EAFE (ND) and the MSCI Emerging Markets (ND) Indexes, which returned 3.38% and 2.29%, respectively, for the first quarter.
Beginning late last fall, we saw a pronounced reversal from a growth-driven to a value-driven equity market, and this rotation has persisted through the first quarter. The market rotation occurred globally—in the U.S., developed, and emerging equity markets—by style (cyclical/value outperformed growth), by market cap (small cap outperformed large cap), and by factor (momentum reversed, while beta remained strong).
Prior to the fourth quarter, U.S. growth-oriented stocks were the dominant outperformers by a large margin, with value-oriented names trading at huge discounts. However, by late in the year and moving through the first quarter, value outperformed growth, with the Russell 3000® Value Index beating the Russell 3000® Growth Index by the widest margin since the first quarter of 2001. Cyclical industries (e.g., oil & gas, machinery, construction materials, and metals & mining), along with the Energy and Financials sectors, took center stage. In contrast, the Information Technology, Consumer Staples, and Healthcare sectors retreated. While large caps have been in favor in past years (FAANG stocks etc.) and still remain ahead over trailing three- and five-year periods, the trend reversed over the six-month reporting period, which saw small caps outperforming. The bond markets took a hit, as investors shifted to equities in anticipation of a broader economic recovery, and the yield curve steepened at the long end. The yield on 10-year Treasuries rose from 0.78% after the election to 1.74% in March—one of the most significant moves in decades.
As economies around the world have begun to reopen, and markets have rallied, the focus is shifting from fear to cautious optimism. Growth in the U.S. gross domestic product (GDP) over the past two quarters reflects the long-hoped-for economic recovery now underway, the reopening of businesses, and the massive government response to the COVID-19 pandemic. GDP grew by 4.3% in the fourth quarter and by an estimated 6.4% in the first quarter. The Biden administration passed the $1.9 trillion American Rescue Plan, although without a single Republican vote. Its proposals for still more fiscal stimulus (the American Jobs Plan at $2.3 trillion and the American Families Plan at $1.8 trillion) will have to pass the gauntlet of a divided Congress; the scope, size, and timing of those plans will no doubt undergo protracted negotiations.
Harbor expects that volatility will remain elevated for the foreseeable future. But we also believe there are thoughtful, practical solutions to manage volatility and enable investors to reach their long-term goals. Our subadvisers are active portfolio managers who remain focused on uncovering opportunities and skillfully executing their strategies to deliver shareholder value in a climate of economic and geopolitical uncertainty, unprecedented health challenges, and financial market volatility. We believe that thoughtful, active management and adherence to enduring investment principles such as diversification, discipline, and a long-term view, will stand the test of time.
Over the past year, we have seen massive disruptions and challenges that have taken a severe toll on human lives. But the human spirit has remained resilient through it all. We believe there is now more reason for cautious optimism than fear as we look ahead.
I hope you and your families stay safe through this difficult time. Thank you for your confidence and continued investment in Harbor Funds.
June 22, 2021
Charles F. McCain
Chairman
Management’s Discussion of Fund Performance
MARKET REVIEW
U.S. equities rallied during the six-month period amid gradually improving sentiment about the prospects for a U.S. economic reopening in 2021. The approval of several COVID-19 vaccines in the U.S. as well as a number of other vaccines globally was followed by a broadening of gains in areas of the market that had been most debilitated by the pandemic and therefore, likely to benefit from a recovery.
The U.S. presidential election in November paved the way to a $1.9 trillion stimulus package in March, consisting of direct payments to individuals and families, additional unemployment benefits and funding for state and local governments, among other allocations. The U.S. Federal Reserve continued to advocate for extreme policy accommodation, citing the pandemic’s drag on the labor market.
Longer-term bond yields rose, reflecting U.S. monetary and fiscal stimulus and rising inflation expectations. The benchmark 10-year U.S. Treasury yield ended the six-month period at 1.63% compared to 0.85% at the beginning of November.
PERFORMANCE
Harbor Capital Appreciation Fund advanced 22.71% (Retirement Class), 22.67% (Institutional Class), 22.52% (Administrative Class) and 22.44% (Investor Class) in the six-month period ended April 30, 2021, slightly underperforming the Russell 1000® Growth Index, which rose 24.31%. The S&P 500 Index returned 28.85%.
Benchmark index sectors gained across the board. The Fund’s holdings also gained broadly but lagged the index somewhat, particularly inInformation Technology and Communication Services.
Tesla (TSLA, Financial) was a standout contributor to returns as the stock gained in the high double digits over the six-month period. The company reported strong financial results driven by solid production, increased capacity, and strong execution. We believe Tesla’s technology, scale, and low-cost advantage make it the breakaway leader in the electric-vehicle market but also position it to disrupt the automotive industry.
The prospect that pandemic restrictions may be lifted later in 2021 buoyed a number of the Fund’s holdings across different sectors, notably Industrials holding Uber (UBER, Financial). In our view, Uber’s ride-sharing platform has the potential to continue to broaden and transform and the company is positioned to achieve better-than-expected profitability post pandemic. Meanwhile, Amazon (AMZN, Financial) continued to benefit from economies of scale and its platform-based business model. Its Amazon Web Services (AWS) business has been an additional driver of revenue and profit.
The Fund’s technology-related holdings gained on strong digitization trends that were accentuated by the remote work environment. Its digital payments holdings also did well as a result of the secular growth of e-commerce and expectations of higher spending as economies gradually re-open.
Underperformers included Alibaba (BABA, Financial), Splunk (SPLK, Financial), and Zoom Video Communications (ZM, Financial), which declined in a rising market. During the six months, we eliminated these small positions and redeployed the proceeds into more attractive investment opportunities.
OUTLOOK & STRATEGY
As fundamental investors, we examine company and industry prospects over the short term and the long term, working to identify the drivers of earnings growth over time. These include high or improving profitability, a strong and defensible competitive position, and growing tangible addressable markets. Investing in companies with long-term growth rates that are well above average and unique, market-leading products and services remains our focus.
Market focus appears to have shifted from fear to optimism and the strength of the coming global recovery. Although interest rates have risen and the demand recovery has raised price pressures we believe inflationary fears will prove transitory as the recovery should normalize once economies around the world reopen in a sustainable manner and as the effects of fiscal and monetary stimulus fade. We further believe the rise in bond yields reflects expectations of more normal levels of growth to come.
We are encouraged by the continued strong financial results of the Fund’s holdings. We remain invested in areas involving the digitization of the enterprise, payments, social media, and e-commerce. The Fund’s focus also includes, in our view, beneficiaries of the recovery in, and broadening of, economic growth.
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 harborfunds.com or by calling 800-422-1050.
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.
There is no guarantee that the investment objective of the Fund will be achieved. Stock markets are volatile and equity values can decline significantly in response to adverse issuer, political, regulatory, market and economic conditions. At times, a growth investing style may be out of favor with investors which could cause growth securities to underperform value or other equity securities. Since the Fund may hold foreign securities, it may be subject to greater risks than funds invested only in the U.S. These risks are more severe for securities of issuers in emerging market regions. For information on the different share classes and the risks associated with an investment in the Fund, please refer to the current prospectus.
Also check out:
