MANAGER COMMENTARY
As of 12/31/2021
“Curtailed fiscal stimulus, tighter monetary conditions, and higher inflation build a case for slowing economic activity in the coming year.”
Jennison Associates LLC
Market in Review
The fourth quarter of 2021 was marked by the emergence of the Omicron variant of COVID-19, as well as heightened concerns over inflation, which led the Federal Reserve to announce an accelerated plan of reduced asset purchases. Against this backdrop, equity markets rose to all-time highs to close out the year. However, growth equities with high valuations underperformed meaningfully. Many of these shares were also at price peaks when concerns arose about the potential impact of rising interest rates on valuations.
Corporate earnings remained strong, finishing the year with robust recovery from pandemic lows. The effects of monetary and fiscal stimulus were visible in the record levels of household and corporate cash, which bolstered demand, and strength in capital expenditure. While supply chains remained tight, the worst of the port and logistics congestion showed signs of easing as the year ended.
The S&P 500 Index and our benchmark, the Russell 1000® Growth Index, posted another year of vigorous gains, with both rising nearly 30%. Microsoft, Apple, Alphabet, Tesla, and Nvidia accounted for more than half of the returns in the growth index for the year and were also important contributors during the fourth quarter. We remain optimistic on Apple and Microsoft; however, despite our significant positions, the benchmark’s high degree of concentration in these names led us to a consistent underweight position in both stocks. Our research-driven, bottom-up process and risk controls deliver a more diversified portfolio, which we believe offers higher growth potential over our long-term time horizon.
This approach was a headwind to relative performance in 2021; however, we believe it will generate strong returns over time, as the next generation of growth leaders demonstrates its competitive advantages and posts growth and profitability ahead of market expectations.
Portfolio Performance
During the fourth quarter, the Harbor Capital Appreciation Fund (Institutional Class, “Fund”) returned 5.00%, underperforming its benchmark, the Russell 1000® Growth Index, which returned 11.64%, and the S&P 500 Index, which returned 11.03%.
The benchmark’s sectors all generated positive performance.
The Fund’s stock selection and positioning in the Health Care sector, as well as stock selection in the Consumer Staples sector, were important sources of returns for the Fund during the quarter. Although stock selection in the Information Technology and Communication Services sectors was a headwind to performance.
Contributors & Detractors
Tesla (TSLA, Financial) posted robust returns during the quarter from strong production and earnings announcements, and from the significant attention that the electric vehicle (EV) sector received due to IPOs in that space during the second half of the year.
Nvidia (NVDA, Financial), the leader in advanced graphics chips, was also a strong performer during the quarter, despite a pullback in December. The company reported revenue growth of 50% and gross margins of 67%—both ahead of expectations.
Snap (SNAP, Financial) detracted from Fund performance. Despite posting 57% year-over-year revenue growth during the third quarter, Snap conveyed weaker-than-expected guidance for the first quarter of 2022, generating concerns among investors that recent privacy changes in the Apple App Store may continue to affect Snap’s advertising revenues.
Following very strong results in 2020, Block’s (SQ, Financial) (formerly Square) stock price was challenged by tough, year-over-year revenue-growth comparisons, particularly related to its Cash app.
Buys & Sells
During the quarter, we initiated a position in KKR (KKR, Financial). The company is one of the world’s largest alternative asset managers, with over $450 billion in assets under management. Pensions and endowments continued to increase their allocation to alternatives, favoring the largest and most successful alternative managers. KKR benefited from this trend and is also expanding distribution into the retail market.
We also established a position in Spotify (SPOT, Financial), after observing evidence of an improvement in gross margins due to the addition of podcasts to the company’s strong music franchise.
Carvana (CVNA, Financial) continued to report strong, used-car unit sales and revenue growth. However, we had apprehensions about slowing growth and operational constraints that raise the risk of disappointment in coming quarters. As a result of this uncertainty, we sold the position.
DocuSign (DOCU, Financial) shares declined during the quarter due to concerns about a demand slowdown. We eliminated the position.
Outlook
We are nearly two years into the COVID-19 pandemic, and much remains uncertain. U.S. economic activity, as measured by GDP growth, rebounded remarkably in 2021, after the pandemic-driven contraction in 2020.
Low levels of absolute and real interest rates have been a feature of the economic landscape for the better part of a generation. The efforts to forestall economic collapse over the past two years have taken this accommodative policy to an extreme and have driven inflation to levels not seen in half a century. In November, policymakers took the first steps to rein in accommodation by announcing a plan to curtail asset purchases, as well as telegraphing the likelihood of increases in the Federal Funds rate in 2022. Curtailed fiscal stimulus, tighter monetary conditions, and higher inflation build a case for slowing economic activity in the coming year.
We use the framework of secular growth to think about the future over our investment time horizon, as many pre-pandemic trends continue to hold or even gain pace. While forecasting is unusually difficult in this environment, we have identified drivers of growth in the Fund companies that are not tied to U.S. GDP growth. However, we believe that the policy backdrop may lead to further valuation pressure, similar to what occurred during the fourth quarter. Moreover, many of the important beneficiaries of the pandemic are facing challenging year-over-year comparisons. We believe that the impact from this comparison should ease over the course of 2022.
Having experienced periods of underperformance multiple times over our long history, we recognize that periodic drawdowns, while uncomfortable, should be expected. This past year was one of these periods, but scarcity of growth and associated levels of premium valuation tend to recalibrate relatively quickly, before returning once again to outperformance for the durable, secular growth opportunities we own.
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.
Views expressed herein are drawn from commentary provided to Harbor by the subadviser and may not be reflective of their current opinions or future actions, are subject to change without prior notice, and should not be considered investment advice.
The views expressed herein may not be reflective of current opinions, are subject to change without prior notice, and should not be considered investment advice.
This information should not be considered as a recommendation to purchase or sell a particular security. The weightings, holdings, industries, sectors, countries, and returns mentioned may change at any time and may not represent current or future investments.
As a result of changing market conditions, total net asset levels, expenses and other statistics may change at any time and may differ from those shown.
